Report No. 26088-JM Jamaica The Road to Sustained Growth Country Economic Memorandum December 4, 2003 Latin America and Caribbean Region Document of the World Bank CURRENCY EQUIVALENTS Currency Unit: Jamaican Dollar (J$) US$l.O =J$ 60.50 (as of December 1,2003) FISCALYEAR April 1to March 31 Vice President: David de Ferranti Country Director : CarolineAnstey Sector Director: Ernest0May SectorManager: Mauricio Carrizosa Lead Economist/SectorLeader: Antonella Bassani Task Team Leader: SanjayKathuria Acknowledgments This Country Economic Memorandum (CEM) was prepared by a core team consisting of Sanjay Kathuria (Task Leader), Errol Graham, James Hanson and Rina H. Oberai. From the core team, the principal responsibilities for different parts of the report were: Chapters 1,3 (Errol Graham); Chapters 2,4 (James Hanson); Chapter 6 (Rina H.Oberai); Chapters 5,7 and Part I(Sanjay Kathuria). Inaddition, Rina H.Oberai provided analytical support for the full report. KinBingWu prepared the first draft of Chapter 5. Michael Corlett, Kevin Tomlinson, and Phaedra Chrousos provided research support. Ayesha Aparakka-Hemantha did the desktop publishing, helped by Margarita Chavez-De Silva and Fernanda Brito. Homa- Zahra Fotouhi helped to secure Dutch trust funds. The Country Director i s Caroline Anstey, the Lead Economist and Sector Leader i s Antonella Bassani, the Sector Manager i s Mauricio Carrizosa and the Sector Director is Ernesto May. The report draws on the work o f an inter-disciplinary team from within and outside the World Bank. Several background papers were prepared for the report. From the University of the West Indies in Kingston, a team consisting of Alfred Francis, Anthony Harriott, Claremont Kirton and Godfrey Gibbison prepared a paper on crime and violence, and also conducted a business victimization survey of 400 firms across the island. Warren Benfield prepared a paper on poverty. From outside Jamaica, a team from the Netherlands Economic Institute prepared papers on trade and competitiveness (HuibPoot), productivity (Eric Bartelsman), and National accounts (Ivo Havinga). Other papers prepared were on infrastructure (David Erhardt, Basil Sutherland and Winston Hay, Castalia Advisory Group), and poverty (Carolina Sanchez-Paramo and Diana Steele, World Bank). The report also drew on the World Bank's cross-country growth analysis done by Norman Loayza, Pablo Fajnzylber and Cesar Calderon. The team benefited from interaction with Pablo Fajnzylber, Indermit Gill, Orsalia Kalantzopoulos, Ali Khadr, Daniel Lederman, Norman Loayza, Humberto Lopez and Arvind Subramanian. Comments were received from Caroline Anstey, Antonella Bassani, Mauricio Carrizosa, Wendy Cunningham, Toby Linden, Yira Mascaro, Ernesto May, Guillermo Perry, Claudia Sepulveda, Roberto Zagha, and country counterparts from the IMF and IDB. The peer reviewers were Nancy Birdsall, Shahrokh Fardoust and Damien King. The World Bank is very grateful for the support of the authorities in the preparation o f this report. The team has benefitedfrom interaction with the FinanceMinister (including in defining the scope of the work), Bank of Jamaica, the Ministry of Finance, the Planning Institute o f Jamaica, the Statistical Institute o f Jamaica, the Ministry o f Education, Youth and Culture, the Department of Economics at the University of the West Indies, the Private Sector Organization of Jamaica, and development partners. The report was discussed with the authorities at a workshop on October 30, 2003, and written comments were provided subsequently. The World Bank i s grateful for the support provided by Dutch trust funds that enabled key backgroundpapers to be prepared by the Netherlands Economic Institute. i TABLE OF CONTENTS Acknowledgements................................................................................................................ i Table of Contents................................................................................................................... 111 ... Abbreviations......................................................................................................................... ix EXECUTIVESUMMARY................................................................................................. xi PARTI:OVERVIEWAND POLICYOPTIONS I Introduction.................................................................................................... 1 I1. . A Configuration of `Bandwagon' Reforms could make a difference............2 I11. The BigPicture: Past and Present.................................................................. 4 6 V. IV. Understanding GrowthinJamaica................................................................. Growth and Poverty Reduction ..................................................................... 9 VI. 13 VI1. Reducing the Fiscal andDebtBurden........................................................... Revitalizing the Financial System................................................................. 17 VI11. Ix. 20 Crime andIts Impact on Business ................................................................. ImprovingEducation Outcomes.................................................................... 24 X. ImprovingJamaica's International Competitiveness..................................... 29 PART11: MAINREPORT Chapter 1: GrowthandPovertyReductioninJamaica I Introduction.................................................................................................... 33 . I1. 34 Who Are The Poor?....................................................................................... Poverty Incidence And Income Inequality .................................................... I11. 36 IV. V. RuralVs.UrbanPoverty................................................................................ Poverty Reduction With No Growth: "The Paradox Of The 19"'s'' ...........38 39 VI. Summary and Issues for the Future............................................................... 46 Chapter2: UnderstandingGrowthinJamaica I Overview........................................................................................................ I1. . Slow Growth. High Investment. Low Employment Generation...................49 50 I11. The Supply Side of Growth........................................................................... 53 54 V. IV. Jamaica's GDP Growth May Be Underestimated ......................................... 59 VI. The Labor Force And Growth ....................................................................... Capital Inputs................................................................................................. 61 VI1. Raising Growth inJamaica............................................................................ 63 ... 111 Chapter3: Reducingthe Fiscal and DebtBurden I. I1. Introduction.................................................................................................... 67 68 I11. The Government Budget................................................................................ Towards SustainableDebt............................................................................. 71 74 V. IV. Reducing and Improving Government Expenditure...................................... 77 VI. Raising Revenue: Taxer andUser Fees......................................................... Fiscal Institutions andGovernance................................................................ 79 Chapter 4: RevitalizingJamaica's FinancialSystem I. I1. Overview........................................................................................................ 85 85 I11. The Causes of Jamaica's Financial Crisis ..................................................... N. Dealing with the Crisis .................................................................................. 87 88 V. Results of the Crisis Revolution .................................................................... 92 VI. The Debt OverhangAndItsEffects .............................................................. The Post-Crisis Improvement InFinancial Sector Regulation. Supervision andthe Solvency Issue................................................................................... 98 Chapter5: ImprovingEducationOutcomes I Introduction................................................................................................... I1. . The International Evidence on Private andSocial Returns to Education......101 102 I11. 103 lV. Progress InEducation Coverage. But Quality Suffered ................................ 107 Inequality. Poverty and Student Achievement .............................................. Social Returnsto Education........................................................................... V. 109 VI. 113 VI1. What has beendone andwhat more canbe done?........................................ Outcomes andPublic Expenditure................................................................. 116 Chapter6: Crimeand itsImpactonBusinessinJamaica I. Introduction.................................................................................................... 121 I1. GovernanceinJamaica: the International Context ........................................ 123 I11. Dimension andTrends in Crime inJamaica.................................................. 126 128 V. N. The Economic Costs of Crime....................................................................... Patternsof Criminal Victimization of JamaicanFirms................................. 138 VI. Policy Options ............................................................................................... 146 Chapter 7: ImprovingJamaica'sInternationalCompetitiveness I Introduction.................................................................................................... 151 I1. . 152 I11. Evolution of Trade inJamaica 1998- 2001.................................................. 154 N. Trade Policy Reforms .................................................................................... Has Jamaica Reapedthe FullGains FromTrade........................................... 156 V. 156 VI. The Decline inCompetitivenessinthe 1990's .............................................. Jamaica's Business Environment for Exports ............................................... 161 iv VI1. VI11. The Performance in Tourism ......................................................................... Decline InThe Apparel Sector Reflects The Decline InCompetitiveness ...166 168 IX. Impending Issues inthe International Trade Agenda .................................... 169 X. Improving the Framework for Exports and Development............................. 170 Listof Text Tables Table 1: Jamaica Selected Economic and Social Indicators. 1980-2001 ........................ . 5 Table 2: Jamaica . MilleniumDevelopment Goals. Achievements and 2015 Target .......6 Table 3: Jamaica . GDPGrowth. Employment Growth and Investment Rates: 1981-2001............................................................................................................ 10 Table 4: Jamaica . Indicators of Consumption (Average Annual Growth Rates) .............11 Table 5: Primary SurplusDeficit (% o f GDP) Requiredto Stabilize the Stock of Public 15 The Annual Economic Cost of Crime. 2001 ........................................................ Debt...................................................................................................................... Table 6: 26 Table 7: Impact of Crime on Business Practice (%)........................................................... 27 Table 1.1: Consumption of the Poor. 1958-1988 .................................................................. 35 36 Table 1.3: Poverty inRuraland Urban Areas (percent of population)................................. Table 1.2: Poverty and Social and Economic Indicators...................................................... 39 Table 1.4: Movement inAverage Wages and EarningComparedto Increase in CPI .........42 Table 1.5: Factor Income Share ........................................................................................... 43 Table 1.6: Jamaica CPI Annual Index and Relative Price of Food ..................................... 44 Table 1.7: Private Remittance Inflows (US$ millions) ........................................................ 45 Table 2.1: Jamaica - GDPGrowth. Employment Growth and Investment Rates: 1981- 50 Table 2.2: Jamaica Estimates of Sources of Growth 1991-2000.......................................... 2001..................................................................................................................... 54 Table 2.3: Jamaica: The Rise inCurrency Holdings, 1991-2000......................................... 58 Table 2.4: Jamaica: Labor Force Indicators, 1991-2000 ...................................................... Table 3.1: Jamaica Fiscal Operations, 1992/93-2002/03....i................................................. 62 70 Table 3.2: Jamaica -Domestic and External Debt, and Structure of External Debt, 1991/92 - 2001/02 .............................................................................................. 72 Table 3.3: Primary SurplusDeficit (% o f GDP) Required to Stabilize the Stock of Public 73 Table 3.4: Jamaica Public Sector Investment Program, 2000/01 - 2003/04 ....................... Debt ..................................................................................................................... 77 Table 3.5: Government RevenuedGDP, Selected Countries, 2000 ..................................... 77 84 Table 4.1: Jamaica's Financial System, 1990, 1995, and 2001............................................ Table 3.6: Fiscal Risk Matrix ............................................................................................... 86 Table 4.2: Jamaica -Fixed Capital Formation and Growth, 1986-2001.............................. 87 Table 4.3: Government Net Credit StockDeposits, Banks, 2000 ........................................ Table 5.1: Returnsto Education of Male Immigrants inUSA by Country o f Birth.............94 106 Table 5.2: Enrollment by School Type in Secondary and Tertiary Education by Consumption Quintile (%), 2000......................................................................... 110 Table 5.3: Highest Examination Passedby Population 14 Years and Over Not Enrolled Table 6.1: International Comparisons of Selected Governance Indicators, 2002 ................113 inSchoolEducational Institution (%), 2001 ....................................................... Table 6.2: Victimization by Sector inwhich Firmi s Located and Type of Crime ..............125 132 V Table 6.3: Reporting and Reporting Outcomes (% of Total Cases) ..................................... 134 Table 6.4: Annual Impact of Crime. Summary .................................................................... 140 Table 6.5: Distribution of Respondents by Selected Measures Taken to Protect Against 142 Table 6.6: The Annual Economic Cost of Crime. 2001....................................................... Crime and Nature of Organization (%) ............................................................... 144 Table 6.7: Impact of Crime on Business Practice (96).......................................................... 146 Table 7.1: Export and Import Growth inJamaica ................................................................ 152 Table 7.3: Competitiveness Rankings for Jamaica and Neighboring Countries. 2001 ........157 Table 7.2: Merchandise Trade and Exchange Rates inJamaica's Economy ...................... 161 Boxes Box 1.1: Measurement of Poverty inJamaica ...................................................................... 34 56 Box 3.1: A Tale of Two Privatizations................................................................................. Box 2.1: Consumption Indicators......................................................................................... 76 83 Box 6.1: Construction FirminKingston Metropolitan Area................................................ Box 3.2: The Budget Process................................................................................................ 136 Box 7.1: The Impact of an Appreciated Exchange Rat ........................................................ 159 Box 7.2: The Pass Through from the Exchange Rate to Prices............................................ Box 7.3: Inadequate InfrastructureLimits Investments, Competitiveness and Growth.......160 164 Box 7.4: The Decline of the L aModa Garment Company................................................... 170 Figures Figure 1: Jamaica . HeadCount ........................................................................... Poverty 7 Figure 2: Jamaica: Poverty HeadCount Actual and Regression Prediction ...................... Figure 3: Jamaica: Fiscal Revenue and Expendituresb y Type. 1991/92-2002/03 .............814 Figure4: Jamaica: Total Public Sector Debt to GDP......................................................... Figure 5: Jamaica: Bank Credit to the Public and Private Sectors. 1994-2002..................14 18 Figure6: GDPGrowth and Total Debt (% GDP) in 86 Countries..................................... 19 Figure7: School Enrollment by Age and Consumption Quintile. 2000............................. 21 Figure 8: Lorenz CurveDistribution of Public RecurrentExpenditure by Level of Education and by Consumption Quintile. 2000................................................... 23 Figure9: Jamaica's International Ranking on Selected Governance Indicators. Figure 11: ...and as its Share inWorld Exports Fell.......................................................... Figure 10: As its REER Appreciated. Jamaica's Share of Exports in GDP Declined.........25 2002/2003 ............................................................................................................ 30 30 Figure 1.1: Jamaica: Poverty HeadCount (% of Population) .............................................. 35 Figure 3.1: Jamaica: Fiscal Revenue and Expenditures by Type. 1991/92-2002/03 ............47 Figure 1.3: Jamaica Poverty Head Count: Actual and Regression Prediction ..................... Figure 1.2: Poverty (%). Annual Inflation (% p.a.) and Annual GDP Growth (% p.a.) ......40 69 Figure3.2: Jamaica: Total Public Sector Debt to GDP........................................................ 72 89 Figure 4.3: Jamaica: Bank Credit to the Public and Private Sectors 1994-2002..................90 Figure4.2: RealGDP in Selected Crisis Countries. (First Crisis Year = 100)..................... Figure 4.1: Fiscal Cost of Banking Crisis (as Percentage of GDP)...................................... 93 Figure4.4: GDPGrowth andTotalDebt (% GDP)............................................................... 95 vi Figure 4.5: Commercial Bank Loan Ratesand Inflation. EndJune ..................................... 98 Figure 5.1: School Quality According to Employers' Appraisal......................................... 107 Figure 5.2: School Enrollment by Age andConsumption Quintile. 2000............................ 110 Figure 5.3: Percent Correct inMathematics. Junior High School Certificate Examination. 1997-2000............................................................................................................ 111 Figure 5.4: Percent Correct inLanguage. Junior High School Certificate Examination. Figure 5.5: Percentage of Eligible Cohort Taking CXC. 2001............................................. 1997-2000............................................................................................................ 111 111 Figure 5.6: Percentage of Total Passes of CXC Candidates. 2001....................................... 111 Figure 5.7: CXC Performancein9 CaribbeanCountries..................................................... 114 Figure 5.8: English CXC PassingRate (9%) and Class Hours in Eight Caribbean Countries ............................................................................................................. 114 Figure 5.9: Lorenz Curve Distributionof Public Recurrent Expenditure by Level of Education andby Consumption Quintile. 2000................................................... 115 Figure 6.1: Jamaica's International Ranking on SelectedGovernance Indicators. Figure 6.2: Jamaica's Relative PerformanceinLaw and Order. 2003 (112 Countries).......124 2002l2003 ............................................................................................................ 126 Figure 6.3: Trends inRates of Major Crimes inJamaica. 1970-2001.................................. 127 Figure 7.1: Tariff Reformin the 1990s................................................................................. 155 Figure 7.2: As its REER appreciated. Jamaica's Share inWorld Exports Fell.................... 158 Figure 7.3: ... and as its Share of Exports inGDP declined ................................................ 158 Figure 7.4: Jamaica's Regional Tourism Share Suffers as the Exchange Rate Appreciates ......................................................................................................... 167 Annexes 175 Annex 6.2: Methodology for Business Victimization Survey.............................................. Annex 6.1: Identifyingthe Determinants of Crime.............................................................. 181 Annex 6.3: Case of Service Station near Montego Bay ....................................................... Annex 6.4: Case of FurnitureManufacturing FirminKingston Metropolitan Area............ 183 185 Annex 6.5: Program DESEPAZ. Desarrollo. Seguridady Paz (Development. Security andPeace) inCali. Colombia .............................................................................. 187 Annex 6.6: Police and Community Cooperation for Reduction of Violence inDiadema. Sao Paulo. Brazil ................................................................................................. 189 Annex 6.7: Citizen Culture inBogota (Cultura Ciudadanaen a la Alcadia de Bogota). Annex 6.8: Focus on Youth: the Model of the City of Boston. Massachussets.USA.........190 Bogota. Colombia ................................................................................................ 191 Annex Tables Annex Table 1.1: Jamaica. Price Inflation. 1990-2002..................................... Consumer 195 Annex Table 2.1: Jamaica-MainAggregates of GDP. 1990-2001.................................... Annex Table 2.2: Jamaica-GDP by IndustrialSectors. current J$. 1990-2001.................196 Annex Table 2.3: Jamaica-GDP by Industrial Sectors. constant J$. 1990-2001...............197 Annex Table 2.4: Jamaica-GDP by IndustrialSectors. % growth. 1990-2001.................198 199 Annex Table 2.5: GrowthAccounting Adjusting for HumanCapital. 1961-2000 ..............200 vii Annex Table 2.6: Jamaica Determinants of Change in GDPPer Capita........................... . 202 Annex Table 2.7: Jamaica . Force and Employment by IndustryGroup andLabor Labor 203 Annex Table 3.1: Jamaica -Non-financial Public Sector Debt........................................... Status (`OOO), Annual Average ................................................................ 204 Annex Table 3.2: Jamaica . External Public Debt Outstanding .......................................... 205 Annex Table 3.3: Jamaica . Central Government Revenues and Grants, 1996/97 . 2002/03 (9%of GDP)................................................................................ 206 Annex Table 6.1: Crime Rate Indices for Jamaica, 1970-2001............................................ 208 Annex Table 6.3: Murder Rates b y County and Parish, 1984-2001..................................... Annex Table 6.2: Jamaica and New York :Murder Rates for 100,000, 1970-2000 ............207 209 Annex Table 7.1.1: Jamaica's Major Exports and Imports (US$ million) ........................... 210 Annex Table 7.2: Jamaica: Balance of Payments Summary................................................ Annex Table 7.3: ForeignDirect InvestmentinJamaica (US$ million), 1998-01...............211 212 Bibliography ................................................................................................................. 213 ... V l l l ACP African, Caribbean, and Pacific AG Auditor-General ASD Additional Stamp Duties CAD Current Account Deficit CARIBCAN CaribbeanCanadaTrade Agreement CARICOM CaribbeanCommunity CBI CaribbeanBasinInitiative CBTPA CaribbeanBasinTrade PartnershipAct CCI Current CompetitivenessIndex CET Common External Tariff CFAA Country Financial Accountability Assessment CGCED CaribbeanGroup for Cooperation inEconomic Development CMT Cut make andtrim CPI Consumer Price Index CRI Crime Rate Index cxc CaribbeanExamination Council DBJ Development Bank of Jamaica ECE Early Childhood Education ER ExchangeRate ESSJ Economic and Social Survey of Jamaica EU EuropeanUnion FAA Financial Administration andAudit Act FDI Foreign Direct Investment FINSAC Financial Sector Adjustment Company FTAA Free Trade Area of the Americas GCI Growth Competitiveness Index GCT GeneralConsumption Tax GNFS Goods andNon-factor Services IDB Inter-American Development Bank IFS International Financial Statistics IMF International Monetary Fund JDIC JamaicaDeposit InsuranceCorporation JHSCE Junior High School Certificate Examination JLP Jamaica Labor Party JPSCo Jamaica Public Service Company JSLC Jamaica Survey of Living Conditions KMA Kingston Metropolitan Area LAC Latin America and the Caribbean MFA MultifibreAgreement MOEYC Ministry of Education, Youth and Culture MOU Memorandum of Understanding NAFTA North AmericanFree Trade Area NHT National Housing Trust ix NPL Non-performing loan NWC National Water Cornmission PAC Public Accountants Committee PAYE Pay-as-you-earn PIOJ Planning Institute of Jamaica PNP People's National Party PSP Public Sector Investment Program QRs Quantitive Restrictions REER Real Effective ExchangeRate SCJ Sugar Company of Jamaica SCT Special ConsumptionTax SESP Social, andEconomic Support Program SLC Survey of Living Conditions SME Small andMediumSize Enterprises SP&CMP Strategic Planning & Community MobilizationProject STATIN Statistical Institute of Jamaica TFP Total Factor Productivity TRN Taxpayer RegistrationNumber UN UnitedNations UNDP UnitedNations Development Program UNICEF UnitedNations Children's Fund UNODC UnitedNations Office on Drugs andCrime UWI Universityof West Indies VAT Value Added Tax WDI World Development Indicators WTO World Trade Organization X JAMAICA: THE ROAD TO SUSTAINED GROWTH EXECUTIVE SUMMARY Jamaica's economic history i s a story of paradoxes and potential. It has an English-speaking and a reasonably well-educated labor force, i s close to the world's largest market, the USA, and has an abundance of natural beauty, which has spurred tourism. Many of its social and governance indicators are strong. School enrollment for 6 to 14 year olds is near universal. Poverty declined significantly in the 1990s, and i s below the average of comparable countries. Nonetheless, measured GDP growth has been disappointing since 1972, and was negligible over the 1990s (although growth in the 1990s may be underestimated) despite high measured rates of investment. Agricultural and manufacturing output fell. Employment has declined since the mid-1990s owing to the large fall in formal private sector employment, and the equivalent o f 80 percent of the tertiary graduates during the 1990s are estimated to have emigrated. Crime rates are very high. Government debt reached 150 percent of GDP in 2002/03, one of the highest ratios in the world. The particular confluence of changes that helped reduce poverty in the 1990s i s unlikely to continue in the current decade, andmay even reverse. Sustained growth will be fundamental to further declines inpoverty and Jamaica's realizing its potential. This paper offers policy options for increasing growth in a sustainable way. In doing this, it attempts to explain the paradoxes of low growth in GDP and employment despite high investment and strong poverty reduction. Achieving sustained growth will involve dealing with the growing debt burden on a very urgent basis, ensuring a sustainable fiscal situation, and improving international competitiveness. Competitiveness i s beginning to improve with the recent depreciation of the exchange rate but will also depend on limiting increases in public and private sector real wages, and on improvements in infrastructure. Efforts will also be needed to reduce crime, which i s a major cost to business and a major deterrent to the quality of life inJamaica. Education quality needs to be improved and the subsidy to tertiary education reduced in order to stem its drain on the treasury and improve equality. Jamaica's poor growth performance has a number of well-known explanations, but they need to be supplemented for the latter half of the 1990s by the loss of competitiveness. The negligible (measured) GDP growth in the 1990s i s usually attributed to two factors: an adverse external climate and the financial crisis that arose from bank privatization to poorly capitalized investors, and financial liberalization unaccompanied by appropriate regulatory strengthening. These two factors offset the liberalization in the real economy at the beginning of the decade. In addition, the second part of the decade was characterized by an appreciating real exchange rate induced by the approach to monetary policy, rising real wages, rising costs associated with rising crime, and an increasing burden of government consumption, all of which reduced international competitiveness to the point where the output of agriculture and manufacturing declined, and tourism lost some of its share of the Caribbean market. The poverty headcount was halved between 1992 and 1998 despite negligible measured GDP growth, which can be largely explained by a conjunction o f several factors particular to the period. First, GDP growth could be underestimated by 1-2 x i percentage points per annum in the second half of the 1990s, judging from the growth in consumption of power and meat and fish, as well as the rapid growth o f currency usage. The underestimate may reflect the difficulty of estimating GDP in an increasingly service-dominated economy, particularly one that i s highly open, and where the informal sector i s large. Second, inflation, which hurts the poor disproportionately, fell sharply. Third, the relative price of food declined, owing largely to trade liberalization and the appreciation in the real exchange rate, which reduced a major element of cost in the budgetof the poor. Other factors inthe decline inpoverty may have been the rise in real wages and remittances, though their role i s less clear. However, inflation i s already low and the real exchange rate has begun to depreciate, not appreciate as in the past. Hence two important poverty-reducing factors are unlikely to continue to operate in the future, which means that further reduction o f poverty i s likely to depend on achievement of sustained growth. The apparent paradox of low measured growth and high measured investment rates can be explained by the underutilization of much of the capital created in the early 1990s, the investment to protect against crime, and the concentration o f investment in a few, rapidly growing sectors that may have some tax distortions and whose contribution to GDP i s hard to measure. Of course, correcting for possible underestimation of the level and growth of GDP would reduce this apparent paradox. Whatever growth has occurred has not created much employment, largely because of the loss of competitiveness in the 1990s that hurt tradable goods production and thereby formal private sector employment. Employment rose less than 0.3 percent per year from 1991-2001. Between 1996-2001, only public sector employment rose, while informal sector employment was stable; both rose as a share of total employment. Despite weak employment and productivity growth, real wages rose, suggesting an imperfectly functioning labor market. Poor employment prospects, along with high crime, have encouraged high rates o f migration, and the equivalent o f 80 percent of tertiary graduates inthe 1990s are estimated to have migrated. Moreover, fiscal and debt dynamics have worsened significantly owing to the resolution of the financial crisis and a rising Government wage bill. Debt i s now about 150 percent of GDP and the Government interest bill i s about 16 percent of GDP. Simply stabilizing the debt at current ratios will require extremely high primary surpluses, exceeding 10 percent o f GDP. This has inevitably led to investor concerns, indicated by increased spreads on Jamaica's international bonds over the last year, sharply increased domestic interest rates and pressure on the exchange rate. Increasing confidence will require not just a stable but a declining debt to GDP ratio, which means that tackling the debt burden will need to be the top current priority of the Government. If the primary surplus were to fall to, say, 6-7 percent of GDP, the ratio of debt to GDP would rise, since a 6-7 percent primary surplus would stabilize the debt to GDP ratio only ifdebt were lower by some 50percentagepoints of GDP. The question, then, i s how can Jamaica restore self-sustaining and job-creating growth? The report argues that this requires improving international competitiveness and productivity, while also tackling short-term exigencies. The policy options are grouped into three categories-those necessary to limit the risk of a crisis and its effect, with a likely immediate impact; those likely to have an impact inthe short-term; and those likely to have an impact in the medium and long-term, but on which action i s nonetheless needed now. This categorization i s based on the time period of likely impact. The report suggests that a `bandwagon' approach to reforms may be needed, with policy actions needed on several important fronts in order to improve prospects for sustained growth, including measures that help avoid crises, since crises hurt the poor and damage growth prospects. Such an approach could involve the following actions: Crisis-proofing actions: Given the current macroeconomic situation, crisis- avoidance measures are necessary. Being vulnerable to a crisis also affects confidence and hence growth, as has occurred in Jamaica. Crisis-proofing would also mean being ready to offer relief to the poor in case a crisis does take place, since it i s the poor who will suffer most if a crisis should occur. Actions along these lines could include: generating large primary surpluses by implementing revenue generation measures and expenditure reduction measures quickly; continuing to strengthen social safety nets; and maintaining and improving transparency and speed of communication of economic news to the public. Actions with short-term impact: These could include: ensuring that the recent gains (since 2002) achieved via real exchange rate depreciation are preserved; reducing significantly the growth o f the public sector wage bill and avoiding policies that will push up the wage rate in US dollars; continuing to search for cost-cutting measures in the public sector, for example by expediting the preparation and implementationof the report of the Task Force on expenditure management; privatizing the remaining public entities and selling Government shares in private entities expeditiously; accounting for and reducing substantially the contingent liabilities taken on by Government, which have often resulted in an increase in national debt; equalizing the effective tax rates across different sectors and extending the tax base through presumptive taxation; eliminating the stamp duties that are levied on selected imports, which will limit the price increases (especially of food) that accompany depreciation; and increasing cost sharing in tertiary education. Actions with mediudong-term impact: Such actions would be critical for improving sustainable growth prospects over time, and could include: tackling crime with all-out and systematic efforts (through improving information on crime and its incidence, improving clear-up rates for violent crimes, and applying targeted interventions); putting more effort and resources in schools where low income students study, gradually reducing wage compression in teacher salaries, and increasing reliance on private schools that strive for quality improvement; reducing the cost and providing better coverage of water and sewerage services, improving roads, especially rural roads, and improving the reliability of power supply, and ensuring that all these are fully financed by user charges, Le., by levying and increasing tolls and user fees on existing and upcoming infrastructure facilities; increasing transparency in accounting for contingent liabilities and thereby limiting their growth; and improving lending to the private sector, especially small borrowers, by accelerating the starting up of credit registries. Finally, given that policy choices are likely to be difficult, an approach based on social dialogue and consensus- buildingis essential to creating ownership for future reforms by all stakeholders, and for maintaining and improving social peace. xiii POLICY MATRIX *** ** Policies necessary for crisis-proofing (reducing vulnerability), immediate impact * Policies with short-term impact Policies with medium and long-term impact (Note: the above categorization indicates the time period of likely impact. Policy action is needed on all fronts in order to improve sustained growth prospects.) Kev Constraints Policv Options 1. The debt crisis andfiscal deterioration Increase primary surplus, control wage bill and contingent liabilities and increase government investment Debt/GDP has nsen from 79 percent in 1996/97 to about 150 percent in 2002103, and domestic debt *** Increase the primary surplus, the key from 35 percent to 90 percent. The rise reflects the policy instrument. Primary surpluses of large costs of the financial crisis but also over 10 percent of GDP are neededjust to deterioration inother parts of the fiscal accounts. maintain the current, high debt to GDP ratio of about 150percent. Highdebt constrains growth by crowding out private investment as well as productive expenditure in the government budget, and also raises concerns about macroeconomic stability. Fiscal deterioration: The central Government ** Limit growth of wage bill, reduce primary surplus of 10.5 percent of GDP in 1995/96 government employment and non- has fallen to 7.7 percent in 2002/03, while the fiscal interest, non-capital expenditure including balance deteriorated from a surplus of 1.8 percent of contingent liabilities (see below). GDPto a deficit of 8 percent. ** Privatize remaining public entities and Interest costs have risen from 8.7 percent to 15.7 sell Government shares in private percent of GDP; the wage bill has increased from companies. 7.7 percent to 13 percent of GDP; other non- interest, non-capital expenditure from 4.7 percent to * Increase expenditure on infrastructureto 6.9 percent of GDP. crowd-in overall private investment; finance it with user charges. Capital expenditures have fallen from 5.4 percent to 2 percent and businessmen complain about ** Account for and reduce contingent infrastructure bottlenecks. liabilities taken on by Government. Explicit and implicit contingent liabilities are * Limitgrowth of contingentliabilities by growing, createdby government on its own behalf or increasing transparency-classify full on behalf of other public sector entities or even range of direct and contingent liabilities, entities that have beenprivatized. as well as the associated risk, including contingent liabilities from riots, natural disasters and from public sector and `quasi public sector' entities. ** Expedite preparation and implementation of report of Task Force on expenditure management. xiv Extend tax base, rationalize taxes and reduce tertiary education subsidy Revenues are already high, at 29.6 percent of GDP in 2002/03 (tax revenues26.4 percent of GDP). Tax ** Reduce the disparity in tax rates across revenues will need to increase further in order to sectors. make the fiscal and debt situation more sustainable. ** Extend the tax base to include more of This could be achieved if the informal sector could the informal sector by a system of be better taxed and tax rates across sectors presumptive taxes based on consumption rationalized. indicators. * Levy and increase tolls on upcoming and existinginfrastructurefacilities. ** Reduce subsidy on tertiary education (see 3.) * Build social consensus and buy-in for difficult, but necessary, economic policy choices. 2. Pervasive and high crime and violence Identify and measure crime better Jamaica has very high rates of violent crime, * Strengthen official data collection on including the third highest homicide rate in the crime, and conduct frequent victimization world. surveys. These would be an input for policy-making, improving policing Crime imposes major costs on society and business, methods, public debate and better which limit growth (see below). accountability. The empirical foundation for action on crime i s weak. Improve enforcement, increase social capital, and target highcrime areas Crime costs society at least 4 percent of GDP * Upgrade investigative capacity of police explicitly, including lost production, health to improve clear-up rates for violent expenses, and public and private spending. In crime, which would deter such crime. addition, exporting firms' security costs can be as high as 5 percent of sales, small firms' losses due to * Form effective partnerships between extortion, fraud, robbery and arson can be 9 percent police, business and local communities, of revenue, with an average of 3-6 percent for firms by setting common goals and sharing in manufacturing and distribution. information. * Buildsocial capital such as greater trust Crime reduces the efficiency of capital use by and lower tolerance to crime and limiting multi-shift operations, and of schooling violence, especially through interventions because of closures. It results in major implicit social in the home, school and the workplace. costs. * Target high crime urban areas, The costs of crime limit growth. Some 10-20 especially the Kingston Metropolitan percent of firms in the business survey suggested Area, to reduce the impact of crime on the that they may close down in the next three years business community. because of crime. xv Enhance quality of school experience Young males are the most likely victims as well as * Improve the overall quality of the perpetrators of violent crime. Amongst those school experience, especially for poor arrested for major crimes, 53 percent, predominantly students (see below). male, were from the 16-25 age group. About 32 percent of the 15-16 year olds in the poorest quintile * Enhance school programs to include were not enrolled in school in 2001, and even if teaching of social and conflict resolution enrolled, some do not have a positive school skills to students (see below). experience. This breeds frustration and unemployment, leads to a cycle of anti-social behavior, and reduces the contribution of a potentially productive segment. 3. Poor education outcomes Increase focus on early learning Education expanded remarkably, real Government * Increase focus on early leaming- expenditure doubled in the last ten years. By 1989, through teacher training, setting service enrollment was universal for 6-14 year olds. But standards, providing educational material expansion came at the cost of quality. About 30-40 and toys-to improve overall education percent of grade 6 leavers are functionally illiterate. outcomes, making later education less Only 30 percent pass the Caribbean CXC costly and more effective. mathematics examination in grade 11. Jamaican- educated workers receive amongst the lowest returns * Raise functional literacy target to 100 in the US labor market. Poor education outcomes percent in grade 6 instead of the current limit general productivity gains and growth- goal of 80 percent, since functionally measured TFP growth in Jamaica has been negative illiterate are likely to become part of inthe 1990s. youth at risk-see below. Improve incentives and facilities for below-average schools, and make school results public The quality of schools is very uneven-Traditional High School students score much higher than * Allocate funds to schools based on Comprehensive and Primary & Junior High students enrollments, not teacher positions in grade 9 examinations, have better facilities and approved, thus allowing more flexibility teachers, and much higher participation and scores in in the use of funding. the CXC examinations than former Comprehensive * Give special grants to schools with large schools. needs, e.g., a large proportion of students reading below grade. * Provide free foundation books to students in All-Age and Primary & Junior HighSchools. * Create incentives for more qualified and educated teachers to teach in schools other than the Traditional High Schools. * Gradually reduce wage compression in teacher salaries. * Make school results public so that parents and community can monitor progress. xvi Utilize private schools more intensively, Poor students get tracked into lower quality schools, and increaseparental involvement have higher absenteeism, face a more difficult home * Buy places in private schools that target environment, see lower enrollment after age 14 and achieve quality improvement, rather (owing to lack of seats in schools) and higher than construct new schools, to address dropouts, and end up far less educated. All this problem of insufficient school space after creates a vicious cycle of youth at risk, especially grade 9. males, and unemployment and poverty. Tackling these problems would involve a coordinated * Pay private schools to provide approach that would address issues of school quality compensatory, results-based education to of below-average schools (see above), increase repeaters. school space after grade 9, and pay special attention * Increase parental involvement through to those falling behind and reading below grade publicity campaigns to inform parents level. about their role in child learning, such as discouraging absenteeism, providing money for book rental, and creating a more conducive home environment. 4. Inadequate credit access for private sector Start credit registries and improve Jamaica quickly resolved its massive financial crisis, collateral procedures and strengthened financial regulation and ** Reduce the demand for resources by supervision but at great cost. Jamaican Government government, which means increasing the debt is now about 45 percent of bank deposits, about primary surplus-see above. This will twice the share of private credit. With high and increase availability of credit for the relatively risk-free returns on government debt, private sector, gradually reduce interest banks have become more reluctant to lend to private rates, and also improve the incentives for firms, especially small firms and start-ups, which entrepreneurial rather than rentier constrains a potentially vibrant source of GDP and behavior. export growth. In fact, with the current returns on government debt, even some current and potential * Accelerate the start-up of credit entrepreneurs may become rentiers. registries to improve lending quality and quantity. Registries allow financial intermediaries to lend to borrowers more likely to repay and give borrowers an incentive to repay to maintain a good credit record. Credit registries can increase access by including small borrowers and records of loan repayments as well as defaults. * Improve collateral procedures, perhaps by creating debt tribunals separate from the court system, as other countries have done. Lenders and businessmen have complained about the courts' handling of commercial cases. xvii 5. Appreciation of the exchange rate and other Maintain credible macro policies and factors reducing competitiveness in the 1990s continue to encourage exchange rate Jamaica's competitiveness has declined significantly flexibility in the 1990s,reflectedin declining shares of exports *** Maintain credible macro policies. in world trade and in Jamaica's GDP and stagnation Since the exchange rate depends so much in export earnings. This adverse performance is on market sentiment, credible macro closely linkedwith the appreciation of the CPI-based policies, especially reducing the debt REER over 1992-98, and an even greater overhang and maintaining a high primary appreciation in the wage-based MER. Besides surplus will be crucial to prevent an creating incentives for production of more non- excessive correction in the exchange rate, tradables, the appreciated exchange rate also reduces which could spark high inflation and growth, since it i s the export and import-competing increase poverty incidence. sectors which usually see the most rapid productivity increases. ** Ensure that policies do not offset the gains in competitiveness achieved via real exchange rate depreciation since 2002, which would also require that public and private sector wages do not increase in US dollar terms. Improve enabling environment for Survey results show that exports have been hurt by exports high wage increases in the 1990s, exchange rate appreciation, high and rising crime, difficulties in * Encourage employers and trade unions accessinginputs, and highcost of utilities, adding up to conclude productivity-based wage to an increasingly high cost economy. The most agreements to prevent future erosion in successful exports are based on exploitation of competitiveness. naturalresources, especially tourism and bauxite, but * Improve quality of infrastructure and even tourism has been hurt by the above constraints, extend coverage, especially for water and and the once successful apparel sector is in the roads, by levying and increasing tolls and doldrums. High wage costs are especially user fees. constraining. Besides the direct effect of high wages on private sector costs, the high share of wage costs * Improve access to imported inputs by in the government budget leadsto higher deficits and making customs procedures more more crowding out of private borrowing and of efficient. productive government expenditure (see above). ** Eliminate the stamp duties that are Also, the imposition of additional stamp duties has levied on selected imports, especially generatedupward pressure on prices for the average food, which will reduce the price Jamaican consumer. increases that accompany depreciation, and so reduce the potential impact on the poor of food price increases. xviii JAMAICA: THE ROADTO SUSTAINEDGROWTH PART I:OVERVIEW AND POLICY OPTIONS I. Introduction 1. This review of Jamaica's poverty and economy by the World Bank comes after a long hiatus. It follows up on the commitment made in the Country Assistance Strategy of November 2000, and i s a major milestone in the World Bank's deeper engagement with Jamaica. It i s complemented by a Bank study on `Youth Development in the Caribbean,' first presented at the CGCED meeting in June 2002. It will be followed up by a Public Expenditure Review. Also, Jamaica i s a key component of an ongoing report on Tertiary Education in the Caribbean, as well as of a proposed analysis of the likely impact on Caribbean countries of trade negotiations in the context of the Doha development agenda, the FTAA and the Cotonou agreement with the EU. 2. In the 1990s, poverty in Jamaica was reduced despite negligible growth in measured Gross Domestic Product (GDP) and a major financial crisis, owing to a conjunction of several factors. However, these factors are unlikely to continue to operate (see section 111) and, moreover, there is the additional drag on poverty reduction imposed by the current fiscal crisis. Future sustained reduction in poverty is therefore likely to depend on sustained growth in the Jamaican economy as well as the implementation of policies to ensure that the poor are empowered to take advantages o f the opportunities that arise from increased growth. 3. Accordingly, the report focuses on reducing impediments to sustained growth, paying particular attention to policies that will continue to reduce poverty. It i s divided as follows: an Executive Summary and Policy Matrix; Part I, which provides a fuller Overview and Policy Options; and Part 11, which comprises the Main Report and provides the analytical backing and details behind the conclusions and policy options. 4. Part Iof the report is organized as follows. Section 11 highlights the most important policy issues that bear consideration. Section IIIdiscusses some of the major successes in the 1990s, as well as the areas where Jamaica fell behind. Section I V analyzes the reasons for the trends in poverty, and points to the need for growth in order to reduce poverty in the future. Section V provides a discussion of growth and productivity, and shows that growth i s probably underestimated, but i s nevertheless very low. Section VI analyzes the grave fiscal challenge that confronts Jamaica, including issues of debt "inability, crowding out and the decline in public investment. Section VI1discusses the financial sector crisis and its costs, while pointing to the improvement in governance of the financial sector and the functioning of the financial institutions. Section VIII explores the education sector, trends in enrollment and outcomes, and the reasons for less than satisfactory outcomes. Section E, on crime and its impact on business, starts by providing a comparative picture on Jamaica's governance indicators, analyzes trends in crime and estimates the economic costs of crime, and discusses firms' coping strategies on the basis of a business victimization survey. Section X discusses trends in competitiveness including the exchange rate and the export environment for firms, and provides case studies of tourism and apparels. Each of sections 111-X also provides policy options. 5. Part I1 of the report, which provides the analytical backbone for this study, follows an organization similar to Part I, and consists o f seven chapters, with Sections IV to X in Part Icorresponding to Chapters one to seven inPart 11. 11. A Configuration of `Bandwagon' Reforms could make a difference 6. What can be done? This report concludes that there i s no magic wand to kick- start sustained growth in Jamaica. Raising growth in a sustainable way i s likely to be a slow process. This owes to the twin tyrannies o f the very large debt overhang and the high level of violent crime, both of which are amongst the highest in the world. These are key underlying reasons for Jamaica being a high cost economy, and for its lack of competitiveness and growth (see Sections VI1 and E),and have encouraged the departure of human capital (whose development i s heavily subsidized by Government, see section VIII) from Jamaica. 7. But with concerted action on several fronts-a `bandwagon' approach-it is possible to make a difference. Simultaneous, coherent and mutually reinforcing action on several fronts can serve not only to increase growth that i s self-sustaining and job- creating, but also to improve perceptions, so vital to both domestic and foreign investment. This requires improving international competitiveness and productivity, but of course short-term exigencies need to be tackled. Some of the most important ingredients in a `bandwagon' approach to reform are outlined below. 8. Crisis-proofing actions. Given the current macroeconomic situation, crisis- proofing (borrowing from Williamson 2003), which will help reduce the risk of a crisis, i s a top priority, especially since it i s the poor who will suffer most during a crisis. Moreover, being vulnerable to a crisis also affects confidence and hence growth, as has occurred in Jamaica. Also, in case a crisis does occur, its impact on the poor could be mitigated by pre-crisis strengthening of safety net schemes, which would enable the Government to offer quick and well-targeted relief to the poor. Such policies could include: 0 Generating large primary surpluses by implementing revenue generation measures quickly and cutting expenditures where possible. 0 Continuing to strengthen social safety nets, an area where Jamaica has been devoting much attention. 0 Maintaining and improving transparency and speed o f communication of economic news to the public. 9. Actions with short-term impact. These could include: 2 Ensuringthat policies do not offset the recent gains in competitiveness achieved via real exchange rate depreciation since 2002. Reducing the growth of wage costs in the public sector by reducing public employment and limiting wage growth, and avoiding policies that increase wages in U S dollars. Continuing to search for cost-cutting measures in the public sector, for example by expediting the preparation and implementation of the report of the Task Force on expenditure management. Privatizing the remaining public entities and selling Government shares in private entities expeditiously. Accounting for and reducing substantially the contingent liabilities taken on b y Government, which have often resulted in an increase in national debt. Equalizing the effective tax rates across different sectors and extending the tax base through presumptive taxation. Eliminating the stamp duties that are levied on selected imports, which will limit the price increases (especially of food) that accompany depreciation. Increasing cost sharing in tertiary education, and moving the student loan scheme in tertiary education away from reliance on public resources to the private sector. 10. Actions with mediudong-term impact. These actions are necessary since they would be critical for enhancing sustainable growth prospects over time, and could include: Tackling crime with all-out and systematic efforts, including better information on crime and its incidence, improving clear-up rates for violent crimes, and applying targeted interventions. Putting more effort and resources in schools where low income students study, gradually reducing wage compression in teacher salaries, and increasing reliance on private schools, in order to improve the quality and skills of the labor force. Reducing the cost and providing better coverage o f water and sewerage services, improving roads, especially rural roads, and improving the reliability of power supply, and ensuring that all these are fully financed by user charges, Le., by levying andincreasing tolls anduser fees on existing andupcoming infrastructurefacilities. Increasing transparency in accounting for contingent liabilities and thereby limiting their growth. Improving lending to the private sector, especially small borrowers, b y accelerating the start-up of credit registries and improving collateral procedures. 11. The difficult policy measures highlighted above require social consensus. An approach based on social dialogue and consensus-building i s essential to creating ownership for future reforms by all stakeholders, and for maintaining and improving 3 social peace. Countries such as Ireland formulated a tripartite social pact in 1987 between unions, employers and government (later widened to include voluntary and community organizations, representatives of the unemployed and women's groups) to help evolve a national consensus to support large macroeconomic adjustments, including the fiscal crisis of the 1980s (McCarthy 2001). In Mauritius, an economy similar to Jamaica in many respects such as size, and dependence on tourism and sugar, social and political consensus was achieved despite inequality and diversity in ethnic composition, and helped in the evolution of strong domestic institutions that played a key role in Mauritius' strong economic performance over the last three decades (Subramanian and Roy 2002). 111. The BigPicturepast and Present 12. Jamaica has not lived up to its early promise. Jamaica has many advantages- proximity to the world's largest market, an English-speaking work force, fairly good initial endowments, and widespread education. Spurred by the development of bauxite miningand tourism, it enjoyed rapid GDP growth of 6.3 percent annually between 1952- 72. However, the period since then has been quite difficult-per capita income has been stagnant for the last three decades, and major macroeconomic problems have periodically occurred, including high inflation, large debt accumulation, and, most recently in 1995, a financial crisis. Many of these problems arose from various combinations of economic nationalism, two oil price shocks, declining export prices, and political unrest. To address many of these problems, Jamaica implemented a series of broad-based reforms, especially since the late 1980s. 13. Jamaica achievedsome major successes inthe 1990s,particularly inreducing poverty and inflation (Tables 1and 2), and cleaning up quickly, albeit expensively, the huge financial crisis. In spite of low measured growth, poverty incidence was halved between 1992-2001 (section IV). Inflation has been reduced to single digits since 1997, an unprecedented post-Independence record. The financial sector was cleaned up quickly, although the cost of the financial crisis was one of the largest in the world in terms of GDP. Inaddition, international reserves reached new highs with major increases in 2000 and 2001. The tax effort has been consistently strong, varying mostly between 25-27 percent of GDP, which i s among the higher rates in the developing world. Fiscal management benefits from a relatively strong legal and institutional framework. Enrollment in school in the 1990s continued to expand in early childhood, senior secondary and tertiary education, following near universal primary enrollment of all children between 6 and 14by 1989. Finally, and importantly, Jamaica comes out well in cross-country comparisons of democratic traditions and institutions, voice, government stability, quality of the bureaucracy, and the regulatory framework. 14. Millenium Development Goals (MDGs). Jamaica is likely to meet many of these goals (Table 2), including those on poverty and under 5 malnutrition, universal primary education, and access to safe drinking water, though it i s unlikely to meet the targets on child and maternal mortality (even thought the proportion of births attended b y skilled health personnel remains high at 95 per cent). Also, HIV/AIDS has been spreading, with the youth being particularly vulnerable. On education, while net primary 4 Table 1: Jamaica SelectedEconomic and Social Indicators, 1980-2002 - 1980 1990 1995 1996 1997 1998 1999 2000 2001 2002 AVg. 1995-2002 Poverty and Social Population(million) 2.13 2.41 2.49 2.52 2.54 2.56 2.56 2.63 2.60 2.63 2.6 Labor Force(thousand) 699(1981) 1059 1150 1143 1134 1129 1119 1105 1105 1125 1126.1 Poverty (headcountindex) . 28.4 27.5 26.1 19.9 15.9 16.9 18.7 16.8 . 20.3 LifeExpectancy(years) 70.7 73.2 74.4 - 74.8 - 75.3 75.5 75.7 75.1 ~ InfantMortality(per1,OWlive births) - 27.0 - - 24.5 - Gross SchoolEnrollment (%of school-agepopulation) Primary 103.1 101.3 101.5 99.6 99.6 - ~ 95.3 98.7 98.9 Secondary 66.7 65.3 65.7 66.1 - 84.2 83.6 83.3 - 76.6 Unemployment("A of total labor force) 27.3 15.7 16.2 16.0 16.5 15.5 15.7 15.5 15.0 15.1 15.7 GDPand Prices Gross Domestic Product US$billion,currentprices 2.7 4.6 6.6 6.5 7.4 7.7 7.7 7.9 8.1 8.4 7.5 Jamaican $billion, current prices 4.8 33.0 230.2 241.5 262.9 282.2 300.9 338.7 372.2 407.7 304.5 percapita US$, current prices 1266 1907 2631 2582 2923 3016 3010 3016 3112 3203 2937 percapita, constantJ$ (1986baseyear) 6460 (1986) 7996 8111 7938 7725 7629 7542 7548 7642 7686 i728 GDPgrowth, annual %change, constantJ$ -5.7 5.5 0.5 -1.3 -2.0 -0.5 -0.4 0.7 1.7 1.o 0.0 Gross Domestic Investment("AD of GDP) 15.9 25.9 29.3 29.7 29.8 26.7 25.1 27.6 31.0 34.3 29.2 Gross NationalSavings("6of GDP) 10.8 16.0 23.3 24.9 23.2 20.6 20.0 21.1 21.9 17.5 21.6 Consumer Prices,annualchange (%) 27.3 21.9 19.9 26.4 9.7 8.6 6.0 8.2 7.0 7.1 11.6 ExchangeRate,J$ per US$(periodaverage) 1.78 7.18 35.14 37.12 35.40 36.55 39.04 42.70 46.00 48.4 40.0 Real EffectiveExchangeRate 151.5 100 92.4 109.9 126.9 134.2 133.0 130.6 131.8 131.0 123.7 Interest Rate (treasurybill rate, %per annum,eop) 9.97 26.21 27.7 38.0 21.1 25.7 20.8 18.2 16.7 15.5 23.0 Structure of the Economy (%of GDP) Agriculture 8.2 7.1 9.0 8.4 8.0 7.8 7.3 6.7 6.6 6.0 7.5 Industry 38.3 40.5 36.9 34.3 33.1 31.3 31.4 31.5 31.7 31.4 32.7 Manufacturing 16.6 18.6 16.1 15.5 14.9 14.0 14.0 13.7 13.8 13.5 14.4 Services 53.5 52.4 54.1 57.4 58.9 60.9 61.3 61.8 61.8 62.7 59.9 Public Sector (%of GDP)(fiscalyear April-March) 1990191 1995196 1996197 1997/98 1998199 1999100 2000101 2001102 20W03 RevenueandGrants (centralgovemment) 25.9 28.3 26.4 25.4 26.6 29.8 30 27.6 29.6 28.0 Expenditures(centragovernment) 23.7 26.5 32.6 33.0 33.5 34 31 33.3 37.6 32.7 Interestpayments (centralgovernment) 7.9 8.7 11.4 9.4 12.4 13.8 12.8 13.7 15.7 12.2 Primary Balance (centralgovernment) 10.0 10.5 5.2 1.8 5.5 9.6 11.8 8.0 7.7 7.5 AdjustedCentral Govemment Balance' 2.2 1.8 -6.3 -8.7 -12.3 -8.3 -5.5 -5.7 -8.0 -6.6 Public Sector Balance -1.6 2.0 -5.3 -9.2 -10.9 -7.2 -5.6 -6.8 -9.3 6.5 Total Debt 138.3 85.9 79.1 102.3 115.7 132.7 131.9 130.6 148.5 115.8 Domestic 38.1 26.4 35.4 59.3 73.1 90.0 83.6 78.2 89.8 67.0 External 100.2 59.5 43.7 43 42.6 42.8 48.3 54.2 58.8 49.1 ExternalSector Exportsof GoodsandNon-factorServices (US$ mn) 1421.6 2325 3541 3465 3547 3540 3643 3782 3573 3229 3540 Importsof Goodsand Non-factorServices (US$ mn) 1678.3 2928 4246 4231 4504 4502 4507 4989 5248 4829 46.32 Externalcurrentaccount balance(% of GDP) -5.1 -6.8 -1.7 -2.2 -4.6 -4.4 -2.9 -5.0 -10.1 -13.3 -5.5 Net lntemationalReserves,US$ million .442.8(1982) -397.3 428.2 692.6 541.0 582.0 450.2 969.5 1840.7 1597.0 887.7 Gross Reserves, US$ million 105.0 168.2 681.3 880.0 682.1 709.5 554.5 1053.7 1900.9 1645.4 1013.4 1. IncludesFINSACinterest paymentson afull year basis. Source: InternationalFinancialStatistics, IMF; IMF; WorldDevelopmentIndicators,World Bank; EconomicandSocialSurvey, PIQJ 5 Table 2: Jamaica Millenium DeveloDment Goals. Achievements and 2015Taraet - Millenium Development Goal (MDG) Indicators 1980 1985 1990 1995 2000 2001 MDGTarget2015 Status' EradicateExtremePoverty Poverty headcount,national("A of and Hunger population) - 28.4 27.5 18.7 16.8 Half of 1990level On track Achieve UniversalPrimary Education Schoolenrollment,primary (%net) 96.2 94.2 95.7 96.8 95.4 92.8 100.00 Achieved Ratioof girls to boys in primary and PromoteGender Equality secondary education ("A) - 99.4 97.2 100.0 101.0 98.0 Eliminategender Achieved and EmpowerWomen Ratio of young literatefemales to males disparityin (%ages 15-24) 111.0 110.2 109.3 108.3 107.4 107.3 education Mortalityrate, underd (per 1,000live 6.7 (reduceby 213 births) 34.0 27.0 20.0 20.0 20.0 20.0 from 1990) Far behind Reduce Mortality Mortalityrate,infant (per 1,000live births) 28.0 22.5 27.0 24.5 24.5 24.5 Maternalmortalityratio (modeled 30 (reduceby 213 Improve Matema'Health estimate, per 100,000livebirths) - 120.0 106.2 106.2 from 1990) Far behind Prevalenceof HIV,female (%ages15- Combat HIVIAIDS,Malaria 24) and Other Diseases Incidenceof tuberculosis(per 100,000 0'40 (1999) O" Halt spread Lagging people) 7.5 5.6 4.6 4.9 4.9 4.7 96.5 (half of 1990 Ensure Sustainability Improvedwater source (%of population proportionwithout On track with access) - 93.0 - 92.0 . access) UsingUNDPguidelinesfor assesmentof progresstoward each goal. See Human Development Report,UNDP2002. Source:World Bank; Economic and Social Survey,variousissues,PIOJ;PIOJ enrollment is very high, the key issue relates to inadequate quality o f the education system. Also, while gross completion rates in primary education are high (95 percent in 2000), only 68 percent of those who enrolled completed secondary education (World Bank 2002d). 15. Unfortunately, the 1990s also left a legacy of debt, crime, and very low growth. The financial crisis increased the public debt sharply, particularly domestic debt. The debt to GDP ratio was reduced from 138.3 percent in 1990/91to the still high level of 79 percent in 1996/97 but it rose again after the financial crisis and rising fiscal deficits to reach about 150 percent in 2002/03. This debt and its servicing crowds out private borrowing and public capital formation. The crime rate rose in the 1990s (Jamaica has the third highest rate of violent crime in the world), after being quite steady in the 1980s, exacting a major cost on the economy, equivalent to a minimum of 4 percent of GDP every year. Partly owing to these factors, GDP declined each year from 1996to 1999. The 1990s also saw a loss inJamaica's competitiveness, with a decline in market share and total factor productivity, as well as an appreciation of the real exchange rate that hurt tradable goods production. Finally, even as education expanded, outcomes continued to be poor, particularly for the underprivileged. And, the lack of opportunities along with crime, contributed to migration equivalent to nearly 80 percent of the well- educated and highly subsidized tertiary graduates. IV. Growth and Poverty Reduction 16. Poverty in Jamaica declined substantially in the latter half of the 1990s, paradoxically despite a small decline in measured GDP and a major financial crisis. Poverty declined from an estimated 27.5 percent of the population in 1995 to about 17 6 percent in 1999 (Figure 1). Consistent with the general decline in poverty, vulnerability to poverty appears also to be somewhat less in2000 than in 1993. Figure 1: Jamaica Poverty Head Count - (%of population) 1 Poverty = -1.65time t 36.66 40 - 30 - 20 7 Source: Survey of LivingConditions, PIOJ-STATIN,for poverty data. 17. The decline inpoverty is likely due to a confluence of factors particular to the period. First, output probably grew somewhat faster than measured GDP (see Chapter 2). The informal sector and the underground economy have continued to provide employment, which may be one o f the factors in the underestimate of GDP as well as the decline in poverty. Second, inflation, a "tax" that particularly hurts the poor, has fallen. Inflation hurts the poor because more of their assets are in currency, which depreciates with inflation, and because inflation generates larger relative price movements, to which the poor are vulnerable. Third, the relative price of food has fallen, reflecting lower prices of primary products worldwide and the real appreciation of the exchange rate, as well as reduced trade protection. Food, of course, accounts for a major portion of the budgets of the poor. In addition, rising real wages (partly because of backward indexed wage contracts, and partly because o f strong union pressure) and remittances may have helped reduce poverty. However, rising real wages also contributed to the decline in private employment and may have mainly benefited the already better-off workers. Remittances from overseas have grown sharply in dollar terms, but have not increased much as a proportion o f GDP, and in fact declined by 2 percentage points of GDP between 1995 and 1998. Their effect on poverty seems to be one o f maintaining incomes and keepingpeople out o f poverty, rather than raising people out o f poverty. 18. For the period 1989-2001, a strong statistical relationship exists between poverty and real GDP, inflation, and the relative price of food. This relationship explains relatively well not only the sharp rise in poverty in 1991 but also the observed fall in poverty over the latter half o f the 1990s, as can be seen in the low residuals in Figure 2 (see footnote 10in Chapter 1for full details). According to that relationship, the elasticity of the poverty head count with respect to GDP (percent change inthe headcount divided by the percent change in GDP) is 2.8, a relatively large figure by international standards. This elasticity implies a ten-percent increase in real GDP would reduce the head count by the relatively larger figure o f 28 percent, i.e., from the 17 percent currently to 12 percent. A ten-percentage point fall in inflation would reduce the poverty head 7 count by 3 percentage points, Le., from 17 percent to 14 percent and a ten-percentage point reduction in the relative price of food would reduce the poverty head count by almost 4 percentage points, i.e. from 17 percent to 13 percent. O f course, these estimates reflect both any underestimate of GDP growth and the other forces that were at work duringthe decade and their correlationwith these 3 variables. Figure 2 Jamaica: Poverty Head Count Actual and Regression Prediction I 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Note: The predictedequation is basedon the following regression (see Chapter 1): Poverty HeadCount = 48.1 -0.0036** RealGDP t 0 . 3 F Inflation t 37.8' Re1Price of Food Source: Survey of Living Conditions, PIOJ-STATIN,for poverty data, and STATIN for other data. 19. Unfortunately, it is unlikely that the macroeconomic factors that contributed to the recent poverty reduction and offset the impact of slow growth on GDP will continue to operate in the next few years. Indeed the slowing impact o f these factors may explain why the incidence of poverty has leveled off since 1999. Further gains from falling inflation and lower relative food prices are unlikely-inflation has leveled off and the real exchange rate has begun to depreciate. Only further reductions in protection of agriculture, such as cuts in stamp duties, are likely to limit rises in relative prices of food. Growth of the informal sector has helped maintain employment and contributed to unmeasured GDP growth, but it i s unlikely to grow rapidly without faster growth in measured GDP. Whatever the impact of rising real wages has been, it i s unlikely that employers will be able to continue to give wage increases in excess of inflation and productivity, given the openness of the economy and associated competitive pressures. Pressures for wage increases not justified by higher productivity are likely to continue to reduce employment and to slow growth, especially since the need for fiscal stringency will reduce the public sector's demand for labor. Remittances may play a greater role in poverty reduction in the future, assuming remittances continue to grow in dollar terms and the real exchange rate depreciates. Finally, it should be noted that in all countries, poverty becomes harder to reduce as the proportion o f people in poverty decline. A closely related point, as suggested by international experience, i s that the elasticity of poverty with respect to GDP declines as the level o f GDP rises. 8 20. Future sustained reduction in poverty is therefore likely to depend on sustained growth in the Jamaican economy as well as the implementation of policies to ensure that the poor are empowered to take advantages of the opportunities that arise from increased growth. A recent World Bank study, based on cross-country regressions, suggests that on average the income of the poor rises one-for-one with overall growth (Dollar and Kraay, 2001a). 21. It will also be important to ensure that Jamaica's growth is pro-poor-that growth raises the income of the poor at least as much as average income growth, if not more. The poor face a number of problems in benefiting from growth alone. This i s illustrated by the aforementioned World Bank study, which implied that in half the countries, income o f the poor rose less rapidly than overall growth. As in most countries, Jamaica's poor are more likely to be members of larger households, be in female-headed households, have less education, and be employed in the rural sector-agriculture or fishing. In Jamaica, poverty also appears to be strongly correlated with social factors including: teenage pregnancy; single parenting; drug abuse; domestic violence; and child abuse and delinquency, though these associations are often the result of poverty, rather than its cause. As the cross-country evidence demonstrates, policies that promote growth in demand for labor, and access to education, health and social services (as discussed in Sections V, VIII, X), can help to reduce poverty, reduce the vulnerability o f the poor and allow the poor to take advantage o f opportunities that are generated when the economy grows. Policies that address structural rigidities infactor markets will also be important to ensure that Jamaica's growth i s broad-based. 22. Rural poverty is also an issue that should be addressed. The incidence of poverty in the rural areas, at 24.1 percent, i s more than three times higher than that in Kingston. However, the low correlation between the fortunes of agriculture and the level of rural poverty suggests that ruralpoverty issues are much broader than agriculture alone and the non-farm productive sector may require attention. There i s therefore need for a comprehensive rural strategy that embraces the multidimensional nature of rural development. V. Understanding Growth inJamaica 23. Growth in GDP and employment was low in the 1990s while, paradoxically, investment was high. Average measured GDP growth actually was negative over the period 1996-2001 (Table 3). A loss of external competitiveness led to a fall in agricultural and manufacturing output, and also led to the exit from Jamaica of some textile (a major source o f female employment) and tire manufacturing companies. Positive growth was seen only in a few sectors including (a) non-tradable sectors such as communications (average annual growth of 10.5 percent in 1995-2001), and power (5.5 percent); and (b) location- and natural resource-based activities, such as transport (4.5 percent); mining (2.5 percent), and hotels (2.5 percent). During 1996-2001, employment declined at an annual average rate of 0.4 percent, down from the 1.5 percent annual growth in the first half of the 1990s. Only public sector employment has grown; private sector employment has fallen, with the decline of 30,000 in female employment roughly equal to the total decline. (Employment did rise between 2000 and 2002, but this owed 9 largely to an increase in short-term contractual public employment, and there are also questions of statistical comparability of the data). The labor market also appears to be functioning imperfectly, with real wages rising despite weak GDP growth. The wage demands have probably contributed to the decline in employment and generated some substitution of capital for labor. At the same time, investment has been high, about 28 percent of GDP inthe last half of the 1990s and nearly 30 percent in 2001. These figures are similar to the first half of the 1990s and in the top quarter of developing countries. Investment was concentrated in communications, power, hotels, mining, and housing construction. Table 3: Jamaica GDP Growth, Employment Growthand Investment Rates: 1981-2001 - Percentper year GDP growth 0.1 4.9 0.9 -0.7 -1.3 -2.0 -0.5 -0.4 0.7 1.7 -0.3 Employmentgrowth 1.7 2.6 1.5 -0.6 -0.4 -1.4 0.7 -1.0 -1.1 0.6 -0.4 Percentof GDP (nominal) Gross Cap Formation % GDP 20.4 22.7 27.8 27.8 29.7 29.8 26.7 25.1 27.6 30.1 28.2 Construction o/o GDP 10.0 10.8 13.1 12.2 12.6 12.2 12.0 12.4 12.0 12.2 12.2 Machinery & Equip. % GDP 7.3 7.8 9.9 10.9 12.8 10.8 10.2 9.1 11.7 13.4 11.3 Transport Yo GDP 3.1 3.4 4.3 4.5 4.2 6.6 4.3 3.5 3.7 4.3 4.4 Public Investment 8.0 6.9 5.0 3.9 5.6 5.1 2.7 3.1 2.9 Private Fixed Cap Formation 12.4 15.8 22.8 23.9 24.1 24.7 24.0 22.0 24.7 .. Memo: EstimatedGDP EstContiib. Capital Emp. Growth of Total Factor Sources of Growth 1991-2OOO Growth to Growth: Growth Growth Productivity (Residual) Loayzaet ai. (WE sourcesand estimates) 0.3 1.9 1.4 -3.0 Bartelsman(STATINSources and estimates) 0.7 1.2 0.3 -0.8 Sources: National IncomeProduct2001, STATIN; Economicand Social Suwey, PIOJ,various issues; WDliGDF Central database,World Bank; Chapter2. 24. Given the negative growth in GDP, the marginal increase in employment (over 1991-2000), the continued low education outcomes, and high rate of investment, the standard "sources o f growth analysis" suggests that in the aggregate, (total factor) productivity declined over the period (see the summary in Table 3, the discussion in Chapter 2, and Bartelsman, 2002, and Loayza et al, 2002). 25. Jamaica's recent lack of growth is often explained by the financial crisis, the poor external climate, but also by the appreciation of the real exchange rate and increase in real wages, all of which offset the gains from the liberalization of the early 1990s. The importance of all these factors i s borne out statistically in a recent World Bank study (Loayza, et al, 2002). The appreciation of the real exchange rate arose from the post-crisis stabilization, and the rise in real wages hurt tradable goods production in particular. Even tourism, which i s largely priced in dollars, suffered from surprisingly slow growth and loss of market share-the appreciated exchange rate and high wage costs meant lower profits and/or a need for higher dollar prices, reducing competitiveness and the potential income from Jamaica's natural beauty. 26. The costs of crime and the rising government consumption also limited growth. Crime reduced the attractiveness of Jamaica to investors and tourists and required spending on security that did not lead to additional production (see Section IX 10 and Chapter 6). Crime has raised exporters' costs and made it difficultkostly to run multiple shifts, a staple of the textile and call service industries around the world. Jamaica's high tax collections largely go to pay for government interest costs, and other current expenditures that do not contribute to growth (see Section VI and Chapter 3). 27. Some indicators suggest GDP growth may be underestimated but even an adjustment for the possible underestimate would not make growth performance satisfactory. STATIN applies standard techniques to estimate GDP growth, but estimates of the output in the services sector i s always difficult, particularly in an open economy where incomes from tourism and services may be booked offshore. Other issues are the imputed income from housing, which appears low, the size o f the drug economy, and output from the whole informal sector. Finally, the huge increase in imputed banking services, a large negative in the accounts, may bear some reconsideration. Indicators that GDP may be underestimated are the decline in poverty (Section IV and Chapter 2), the rapid growth of some indicators of demand (apparent meat and fish consumption, power consumption and automobile registration, see Table 4), and the rapid growth of currency usage-a standard indicator o f the growth of the underground and informal economy. Nonetheless, growth, even adjusting for a possible underestimate of 1-2 percentage points per annum, has not been high. 28. The apparent paradox of high rates of capital growthhnvestment and slow growth probably reflects the underutilization of much of the capital created in the early 1990s, the costs of crime, and the concentration of investment in a few, rapidly growing sectors that may have some distortions. Much of capital created in the pre- crisis construction boom of the early 1990s and in the development o f export zones now lies underutilized as a result of the lack o f demand and lack of external competitiveness discussed above. Investments to offset crime do not yield increases in GDP, and crime may even reduce the productivity o f existing capital by making it necessary to stop multiple shift operations. Investment remains high in housing, but its contribution to output i s hardto measure. Other recent investment was concentrated incommunications, transport, mining, andhotels, but in some cases output in these sectors i s hardto measure and in some cases the investment may have reflected not simply profit potential that would lead to higher national output but differential taxation rates (Artana and Najas, 2002). Table 4: Jamaica-Indicators of Consumption (Average Annual Growth Rates) 1990-1995 1995-2001 Meat & Fish Auuarent Cons.*(tons) 0.7 6.4 Power Sales (kwh) , I 3.9 6.5 Household Consumersof Power (number) 4.5 4.3 Cars & Trucks Passing the Fitness Test (number) 8.3 8.5 `ApparentConsumption=ProductiontImports-Exports. Source: Economic and Social Survey, PIOJ,TIN, various issues. 29. Whatever growth has occurred has not created much employment, partly because of the loss of competitiveness and the functioning of the labor market. Private sector employment has fallen in the formal sector, obviously hurt by the decline 11 in tradable goods production. Partly the lack of formal employment seems related to large increases in real wages, which has fed back into the loss of external competitiveness. 30. Many secondary graduates and most tertiary graduates continue to migrate, which in turn raises the issue of the large subsidy to higher education (Section VIII). While the average outcomes in education are poor and limit productivity gains, migration continues to be large, suggesting that tertiary education, in particular, performs relatively well. Canada, U S and UK actively recruit Jamaican tertiary graduates like teachers and nurses. The equivalent of about 80 percent of the tertiary graduates in the 1990s appear to have emigrated. High crime rates may be a push factor contributing to migration. High rates of emigration among tertiary graduates, whose education is highly subsidized and who typically do not come from among the poor, raise an important issue of the need to recoup a greater portion of the costs of tertiary education. 31. Generating higher growth in tradables is the key to growth in Jamaica's open economy but is likely to be difficult because of the country's high costs. Dependence on further growth in the informal sector and further increases in public sector employment i s not a viable strategy for improving economic performance. Yet expanding tradables will be difficult without tackling distortions. The impact of exchange rate appreciation (despite recent real depreciation) and high wage increases in the 1990scontinues to keep costs highcompared to Asia or regional competitors. Capital costs are high because of the debt overhang and government demands for financing the debt and its rising non-interest consumption. Crime and security costs generate high overheads. Inadequate infrastructure, especially in roads and water, as well as unreliability of power supply, also acts as a constraint to exports. As a result, imports have substituted for most manufacturing production, other than that protected b y transport costs, and some agro processing. Some exports do occur to the other Caribbean countries but that i s a slow growing market. Other exports are to the niche market o f Jamaicans overseas but, for instance, exports of Red Stripe beer pale incomparison to the success of Mexico's Corona. Export-oriented textile production shifted to the Dominican Republic, Honduras, Haiti, among others, and to Mexico after the formation o f NAFTA (see section X), a loss in GDP of about 1percent. Banana and sugar export are possible largely because of quotas. Sugar i s largely a public sector operation and the attempt to privatize it collapsed because of the unattractive exchange rate, but some of the private sector firms are said to have substantially lower costs. In the lT-related sector, the attempts to take advantage of the big improvement in telecommunications and English language skills have runinto highlabor cost and the crime issue (night time workers need to be transported to and from their homes). The bauxite industry i s still a major contributor to exports, but the falling productivity of the old mines has reduced their dynamism and require substantial investment. Tourism i s competitive because o f the climate and beaches and it continues to bringin substantialforeign investment, even with higher wages, partly because much of the competition i s elsewhere in the Caribbean, which also has high wages in US$. However, the benefits that tourism brings are somewhat eroded b y the subsidies and tax concessions offered by the government. The crime issue, or the perception that there i s a crime issue, also limits tourism growth. 12 Indeed, in the second half of the 1990s, growth of tourism has slowed, and Jamaica has lost out to popular destinations such as the Dominican Republic. 32. Policies that improve international competitivenessand increaseproductivity are thus the key to growth in Jamaica's open economy. Improving competitiveness means wage growth much more in line with productivity; a reduction in crime to reduce its associated overhead costs; better customs services, so smaller firms can access imported inputs better; and a reduction in the tax and interest rate burden imposed by the public sector. Allowing a gradual nominal depreciation would also tend to increase competitiveness: the pass through into prices i s likely to be limited by the weakness of the economy and low inflation in recent years, according to recent research. The resulting depreciated real exchange rate will reduce the local component of costs in U S dollar terms and thereby stimulate output in agriculture, manufacturing and tourism. The events of 2003 have demonstrated that a real depreciation i s possible-in the first half of 2003, the nominal exchange rate depreciated about 15 percent, but consumer prices rose about 7 percent, leading to a real depreciation of 11percent. This real depreciation also demonstrates the enhanced credibility achieved by the central bank in recent times, and that credibility will continue to be key to maintaining the gains in exchange rate competitiveness. It is also important to note the while depreciation will benefit agriculture by raising prices of imported foodstuffs, it will hurt poor urban consumers and raise the burden of external debt. A one-time, step devaluation alone i s unlikely to sustain export growth. Sustained growth in exports will depend on policies that generate a perceptionthat exports will be kept profitable for some time and therefore investment in outward oriented production will pay-off. Finally, better infrastructure will also needed. In addition to general infrastructure improvements, infrastructure will be needed to maintain tourism's dynamism and decisions will need to be made: a) whether to improve infrastructure in existing tourist areas or start new ones, and b) how to pay for it. Unless growth picks up, the demand for labor will continue to grow slowly, and migration (labor export) will continue. VI. Reducing the Fiscal and Debt Burden 33. In the early 1990s, Jamaica made considerable progress in its fiscal affairs. Tight fiscal policy was part of the overall macroeconomic strategy to stabilize the economy and stimulate economic growth. From 1990/91 to 1995/96, the government ran a fiscal surplus and a significant primary surplus (the difference between revenue and non-interest expenditure), although these surpluses declined over the period. These surpluses, plus Paris Club and bilateral debt restructurings, reduced the total public sector debt from US$5427 million (US$3942 million external) in 1990/91 to US$4435 million (US$3070 million external) in 1995/96; the ratio o f debt to GDP declined from 138.3 percent in 1990/91 to 85.9 percent in 1995/96. 34. The financial crisis of the mid-l990s, together with the rising government wage bill and falling revenue over 1996197 to 1997/98 (relative to GDP), worsened the fiscal and debt position dramatically. It i s possible that the trends in revenue and expenditure would have worsened the debt position even without the financial crisis (Figure 3 and Table 3 inChapter 3). However, inresponse to the massive financial crisis, 13 the government replaced all of the financial institutions' weak lending with government debt. Figure 3: Jamaica: Fiscal Revenueand Expenditures by Type, 1991192-2002103 Expenditure 40 35 30 25 2c 20 E 15 0- 10 5 0 35. This policy protected the depositors, but generated a major Government debt increase. The resulting interest costs, together with the deteriorating underlying balance, have,reversed the fiscal gains of the first half of the 1990s as well as 1999/00 and 2000/01. The deterioration occurred despite cuts in government investment that would have been desirable for growth. With the crisis, the economic contraction over 1996- 1999 and then the recent, significant fiscal slippage of 2001/02 and 2002/03, the ratio of debt to GDP has risen to about 150percent of GDP (Figure 4). This i s one of the highest ratios in the world. All this has meant that short-term risks rose substantially, access to external markets deteriorated and the exchange rate came under pressure in 2003. Figure4: Jamaica: Total PublicSector Debtto GDP (including Govt. guaranteeddebt) f 1 Source: IMF; See Table 3.1. 14 36. Reaching fiscal and debt sustainability are critical to a return to sustained growth, but primary surpluses of more than 10 percent of GDP are neededjust to sustain the current, high debt to GDP ratio of 150 percent. This is the case even under optimistic scenarios for growth and interest rates (for example, growth of 2 percent, and real interest of 9 percent). Moreover, the required surplus i s extremely sensitive to growth and interest rates, as Table 5 demonstrates. In addition, reducing the debt stock to 123 percent of GDP by the end of 2005/06 through higher surpluses will demand primary surpluses of about 15-17 percent of GDP (assuming 2 percent growth, interest rates of 15-17 percent, and inflation of 8 percent). In this context, it i s worth noting that the Government in June 2003 floated 2 and 5 year LRS at about 34 percent (implying a real rate of about 25 percent). Finally, since external debt i s now almost 60 percent of GDP, a 1J$ depreciation of the J$ versus the US dollar increases the stock of debt roughly by 1 percent of GDP. To mitigate this, real exchange rate depreciation (which will help improve competitiveness) would need to be accompanied by growth and productivity enhancing measures, and preferably reduction inreal interest rates. 37. Fiscal slippage, to a primary surplus of 6-7 percent of GDP, would lead to a rise in the debt to GDP ratio. A primary surplus of 6-7 percent of GDP, would, under assumptions inthe table, only stabilize debt if the debt were lower by some 50 percentage points of GDP. The near-term challenge for the government i s to chart and maintain a transparent course to improved fiscal and debt indicators in what i s likely to be a less friendly external economic environment. Table 5: PrimarySurpluslDeficit(%of GDP) Requiredto Stabilizethe Stock of Public Debt Note: g: real growth rate; d: debt to GDP ratio; i:nominal interest rate; f: inflation. Source: World Bankstaff estimates 38. Not only has the debt mushroomed, but 60 percent of the debt is now domestic as a resultof the crisis and more is held by private creditors. The share of domestic debt in total debt has risen from 8.3 percent in March 1992 to 60 percent in March 2002, largely because of the crisis and its ensuing impact on the deficit. The share of external debt has fallen correspondingly, though in U S dollar terms, and relative to GDP, external debt has also risen since 1999. Within external debt, the share of concessional debt (bilateral and multilateral) fell from 85.5 percent in fiscal year 1991/92 to 52.6 percent in fiscal year 2001/02. At the same time, the share of private creditors in total external debt grew from 14.5 percent in 1991/92 to 47.4 percent in 2001/02. Apart from this, the Jamaican banking system, which i s emerging from the financial crisis of 1995/96, has more than one-third of its assets consisting of Government debt (which, net of government deposits, represented about 45 percent o f deposits in June 2003). The rest 15 of the financial system (merchant banks, brokers, building societies) also has a large holding o f government debt. 39. To strengthen the fiscal situation and keep debt sustainable, strong Government action is neededon expenditure and revenue. A key element inreducing Government expenditure i s control over wage and salary expenditure, which now accounts for over a third of Government expenditure. Risingreal public sector wages are inconsistent with a sustainable debt ratio and a slow growing economy, unless public sector employment i s reduced, in percentage terms, by more than the increase in real public sector wages. The proceeds from the sale of shares or privatization of the remaining public sector entities could be used to write down the debt, although the proceeds may not be as large as they were in the past. The Government has made progress on the privatization agenda but the experience has been mixed and the Government still has substantial holding in some entities, including Air Jamaica (in which the Government recently increased its holding to 45 percent, after privatizing it in 1994), mining companies, the power company and the sugar industries, and it also owns many relatively small enterprises in activities like agriculture and tourism. In addition, the transfer o f the entities to the private sector could reduce, if not eliminate, the contingent liability risk. Reducing and improving the quality of government expenditure i s an area where more detailed analysis i s required, and will be taken up in the Bank's forthcoming Public Expenditure Review. 40. Revenue increases will not be easy, since Jamaica already has a fairly high ratio of taxes (25-26 percent) and other revenues (2-3 percent) to GDP. Areas for improvement include increasing compliance and increasing reliance on user fees. The growth o f the informal sector, in part, to avoid taxes, has tended to reduce the tax base. Further simplification of the tax system including the merger o f some taxes such as the Education Tax and the National Housing Trust Tax with income tax may reduce transactions cost for tax compliance and encourage more informal sector business to come into the tax net. Another approach to increase informal sector coverage and also to increase revenue from income taxes would be identification of potential taxpayers by a system of indicators such as auto ownership, overseas trips, etc. Also, significant subsidies exist in the tax system and could be reduced. A particular issue i s taxation of the hotel industry, where competition for investment has led to the Government's offering concessions. Finally, fees for tertiary education could be increased to reduce the large subsidy that mainly goes to the better-off, who often migrate. 41. Jamaica's ability to manage the fiscal situation technically is strong, but contingent liabilities need to be better managed. Jamaica i s considered to have a sound legal and institutional framework for fiscal management. A recent assessment of the budgetary process by the World Bank Country Financial Accountability Assessment (CFAA), 2001, confirms the strength o f the budgetary process but also points out some adjustments that would improve efficiency and transparency. In addition to issues of prudent management of expenditures, management of direct and contingent liabilities are also important. Since the central government i s ultimately responsible for the debt or other liabilities of non-central government accounts such as public enterprises, this increases the difficulty of managing the fiscal balance, especially since the GOJ budget 16 includes only half of these accounts. Also, realized contingent liabilities have in the past created budgetary problems, including large debt write-offs. Most recently, inMay 2003, a J$6.3 billion external loan was guaranteed for the sugar industry. In moving towards achieving and maintaining fiscal stability, there i s need for the government to establish a budgetary planning framework that identifies and classifies the full range of fiscal liabilities, both direct andcontingent as well as the associated risk. VII. Revitalizing the Financial System 42. Jamaica's growth, development, and the solvency of the banking system are affected by the debt overhang from the enormous financial crisis of 1995-96. The crisis, one of the largest in the world (in terms of GDP), was resolved relatively quickly and has led to a significant improvement in regulation and supervision o f the financial system, but also to a huge increase in an already large public sector debt. This debt burdens the economy, investment, and the public sector, crowding out private sector credit and public investment, as discussed below, and thereby limits Jamaica's growth. Increasing credit to the private sector, particularly small and medium industries that are potential exporters, and home loan mortgages, will depend on a primary surplus that reduces the importance of public sector debt in the financial system, improved credit information systems to help reduce the risk of lending, particularly to smaller borrowers, and better systems of collateral execution to protect creditors' rights and increase the incentives to repay debt promptly. Given the large share of Government debt in the financial system (in banks equal to about 45 percent o f deposits), maintenance o f Government solvency i s critical to maintaining the solvency of the financial system. Without continued public confidence in the Government's ability to service its debt, which backs the majority of deposits, a run could develop on the banks and the currency that would lead to a new crisis. 43. The seeds of Jamaica's massive financial crisis were sown in the early 1990s' with the privatization of financial institutions to weak investors and the financial liberalization, in the context of weak regulation and supervision. In this environment, and with attempts to tighten monetary policy ineffective, a huge credit boom developed. Credit was allocated poorly by the poorly managed institutions, often highly concentrated and to related parties, according to a study by FINSAC (Financial Sector Adjustment Company Ltd., the agency created in 1997 to deal with the institutions). At the macro level, higher investment, much of it in construction, did not produce growth. Then, inthe mid-l990s, when the government tightened credit to cut inflation, the weakness of the lending was exposed. 44. The crisis was among the world's largest (over 40 percent GDP), but its resolutionwas quick. The government guaranteed all liabilities, replaced bad loans with government debt, and took over institutions and collateral on the loans. Within five years of its formation, in 1997, FINSAC had liquidated or sold all o f the assets that it taken over. The remaining institutions are much stronger. 45. Regulation and supervision were strengthened substantially but further improvements are needed. Regulation has raised capital requirements to 10percent of 17 risk weighted assets and strengthened income recognition and provisioning. Bank of Jamaica's independence in supervision has increased and it has strengthened its prompt corrective action procedures. Consolidated supervision has also improved, but further improvement i s needed, along with better sharing of information with bank supervisors in other countries. Better harmonization of the many new laws and regulations related to finance would also be desirable. 46. The crisis left a massive debt overhang. Jamaican public sector debt, already large before the crisis, i s now about 150 percent of GDP; domestic debt i s about 90 percent of GDP, largely reflecting the replacement of financial institutions' loans by government debt. The resulting 45 percent ratio of government debt to total bank deposits i s one of the highest in the world. Government debt also grew sharply in merchant banks and building societies. Correspondingly, banks' private sector credits have fallen to only about 10 percent of GDP, though there was some rise in 2002 (see Figure 5). Figure5: Jamaica: Bank Credit to the Public and PrivateSectors 1994-2002, percent of GDP Public Sector Credit - 20 - A c 20 15 - --15 A T --10 15° i --5 0 0 Note: Public Sector Credit estimated for 19981997 1994 1995 1996 1998 1999 2000 2001 Sept 2002 Source: Bank of Jamaica; IFS, IMF. 47. The large ratio of public sector debt to GDP raises concerns about Jamaican financial intermediation and growth prospects. Across countries there seems to be a negative relationship between public sector debt and GDP growth (see Figure 6). Three reasons, relevant for Jamaica, probably explain this relationship: 1. The large stock of public sector debt mostly represents claims on future tax receipts and the government's borrowing capacity, not increased productive capital, since the debt replaced loans that were largely unproductive. 2. Higher rates of return on government debt and deposits may turn some potential entrepreneurs into rentiers, with a corresponding loss of economic dynamism, a fear expressed by some Jamaican bankers. 3. Traditional crowding out of private investment. Even with Jamaica's often large primary surpluses, public sector debt has grown relative to GDP. Thus, additional deposits from the public have been absorbed by deficit financing related to the large interest costs. This crowding out of private investment may be by higher 18 real interest rates or by credit rationing to risky borrowers. Foreign loans, mostly short term, have provided some respite but only to the best borrowers. Figure 6. GDP Growth and Total Debt (%GDP) in 86 Countries (Five Yr. Averages, 97-01, IFS data) 10 - 9 - 8 - y = -0.018~ 4.2874 + 7 - * * R2= 0.129 6 - 5 / * :*** ** * * A *`e 1 0 I: j -5 Total Debt (%GDP) Source: International Financial Statistics, IMF. 48. What can be done to increase credit to the private sector? More private sector credit would be desirable, but credit alone cannot lead to a sustained private sector recovery. It makes little sense to increase loans to companies with poor repayment prospects and in any case Jamaica's openness makes lowering the interest rate difficult. 0 More credit could be made available to the private sector by reducing the government's demand for financing - achieving a larger primary surplus as discussed in Section VI and Chapter 4. The small firms bear much of the burden of the crowding-out by public sector debt because of the segmentation of financial markets. Larger firms still have access and may be able to borrow abroad. Note that the Government's attempts to channel credit-it i s now the largest source of housing finance, for example -may add to the future needs for borrowing since in the past the public lending institutions have had poor recoveries and Parliament has questioned the political linkages of the credit programs. Better quality lending, as well as increased access to credit can be encouraged through credit registries. Credit registries can provide better information to allow financial intermediaries to lend to borrowers who are more likely to repay. Moreover, credit registries give borrowers incentives to repay, to maintain a good credit record. If they cover even small borrowers, they can increase access to credit 19 by allowing the small borrowers to build up the intangible asset of a good credit record. However, since banks are often loathe to share information about their clients, credit registries often have to be started by Government legislation. 0 Improve collateral execution, perhaps by creating special courts for debt disputes and bankruptcy. Surveys show dissatisfaction with the courts' performance on commercial issues. 49. From a short run standpoint, the solvency of Jamaica's financial system has become much more dependent on the public sector's solvency, and less on the private sector's servicing of its debt. The full bail-out of the depositors after the crisis, by replacement of all bad private debt with government debt, has left total public sector debt at about 45 percent of deposits, as noted. Hence, Government's capacity to either rollover its debt or service it out of the budget i s critical to the banks' capacity to cover the interest costs of their deposits. Moreover, if the Government debt service ratio becomes large, the public may lose confidence in its capacity to service its debt, on which the interest on deposits depends. Such a loss of confidence may not simply make it hard to rollover government debt; it might generate a run on the banks and the currency. Hence the high post-crisis ratio of Jamaican public sector debt to GDP creates a substantial risk for the financial system and the currency, one that can only be reduced by improving the ratio of the Government's primary surplus to its debt service. VIII. ImprovingEducation Outcomes SO. Jamaica has emphasized education and achieved near universal enrollment and gender parity. By 1989, enrollment was practically universal for children between 6 and 14, and 95 percent for 12 to 14 year olds from the poorest quintile. There i s gender parity at all levels before grade 9. Government commitment is also reflected in average spending of about 6 percent of GDP on education, well above the Latin American region average. In addition, education forms about 5.5 percent of total household spending. 51. Private and social returns to education are positive. Private returns in 1996 to an additional year of education were 5, 3.3, 1.1 and 8.4 percent for primary, secondary, technical and vocational training, and tertiary education respectively. However, the low private rates of return, particularly at the low and middle levels, may reflect not only Jamaica's slow GDP growth but also poor quality (see below and Chapter 5). Social benefits of education include the link to reduced fertility -from over 100live births per 1000 women in the reproductive age group in 1991to 76 in 2002 -leading to a lower school-age population and potentially freeing up resources to improve educational quality. Smaller families also allow parents to devote more resources and attention to their children. Another social benefit comes from positive school experiences, which tend to be associated with much less riskykriminal behavior in survey data. Surveys also suggest that students who perform well scholastically do not want to jeopardize it through risky behavior that may have long-term repercussions. In contrast, the weaker students may feel alienated from the school and school achievement and drop-out into a life of anti-social behavior. Even as the overall school enrollment rate has increased and 20 illiteracy has gone down, violent crime has increased over the last fifteen years (section IX). The dropping out and hence inadequate education leads to more unemployment (unemployment o f 14-19 year old poor youth was 47% in 2001) and may be linked to participation in violence. Poor male children between 14-24 are an especially vulnerable group, prone to be both victims as well as perpetrators of violence. More details on issues and policies relating to youth at risk can be found in the World Bank report on Youth Development in the Caribbean (World Bank, 2002a). 52. With increasing age, enrollment of the poor and of males declines. Overall, 22 percent o f all students enrolled in grade 9, about 11,000 students, still cannot access grades 10 and 11 because o f the lack of school places. The lack of places, social and economic pressures, and quality issues (see below) affect the poor students disproportionately. Enrollment ratios of the poorest and richest quintiles diverge sharply after age 14; by the ages of 17 and 18, the respective enrollment ratios are slightly under 30 percent and 80 percent (Figure 7). Also, while males and females start out equally in enrollment in basic education, a disproportionately high number of males drop out after grade 9, so that in tertiary education females account for about 66 percent of enrollment. Not surprisingly,boys formed 61 percent of the 12-18 year olds out of school in 2000. Figure 7: School Enrollment by Age and Consumption Quintile, 2000 I I I , 3-5 6-11 12-14 15-16 17-18 19-24 1Source:PIOJ-STATIN 2001 Age Groups 53. Other indicators suggest the quality of education is low. About 30-40 percent of students are functionally illiterate at the end of primary education, and about 30 to 40 percent of Grade 6 leavers read below grade level. Absenteeism i s high especially in junior secondary education. Many adolescents are disengaged from educational pursuits, and tend to drop out before completion of the cycle (more pervasive among the poor and boys). The national pass rate of less than 60 percent in Grade 11 CXC (Caribbean Examination Council) Englishexaminations and 30 percent in mathematics i s below that of Dominica, St. Kitts, St. Lucia, Belize, Trinidad and Tobago, and St. Vincent and the Grenadines. In a standardized comparison of workers in the US labor market, for workers educated in Jamaica the return to an extra year o f school was only 3.5 percent in 1990, worse than 53 of the other 66 sample countries. Some of these quality problems partly reflect inequality and poverty, including the family environment, but also the school system (see below). 21 54. The quality of schools is very uneven. At the end of grade 9, students in Primary and Junior High Schools and the former Comprehensive High Schools score much lower in mathematics and English than the Traditional High Schools. Only a small percentage of students in the former Comprehensive High schools participate in the CXC examination, and their pass rate i s half or less that of Secondary High students. These differences partly reflect the selection process and curriculum differences. The academically-oriented, Traditional High schools employ a higher proportion of university-educated teachers. Textbook and ancillary educational equipment also are better in Traditional High Schools. The highest proportion of untrained teachers i s concentrated inrural schools. 55. Poor students get tracked into lower quality schools, and their home environment exacerbates the situation. Richer children receive better quality education. Students from affluent families attend private preparatory primary schools and pay for extra tutoring to prepare for the end of the primary cycle (grade 6) examination. This better preparation allows them to be placed in better schools- in 2000, about 43 percent of students in all-age schools were from the poorest quintile, while over half of the students inthe academic, traditional high schools were from the top two quintiles. In tertiary education, 91 percent of students were from the top two quintiles. Also, school attendance i s far more irregular for poor students-in 2001, only 60 percent of the poor students had full attendance, compared with 87 in the richest quintile. Poorer students also live in homes with a greater chance of not having a father figure. For boys, the absence o f a male role model contributes to lower achievement, lower educational aspirations, absenteeism, and the risks of dropout and delinquent behavior. 56. The poor thus end up far less educated, which creates a vicious circle of poverty. Facing these handicaps, it i s not surprisingthat the poor tend not to participate inor fail CXC examinations (the key examination for admission into tertiary education or finding ajob). The adult population in the bottom quintile has disproportionately fewer academic qualifications-86 percent of the poorest quintile possess no academic qualification, compared with 52 percent for the richest quintile; none of the poor had a tertiary degree, while 12 percent of the richest quintile did. Looking at it another way, the richest quintile forms the vast majority o f those with degrees or those with 3 or more A levels. 57. Jamaica spends more on education than many countries but ends up with less satisfactory outcomes. Jamaica has been spending an average of over 6 percent of GDP on education over the last five years, more than most of its Caribbean neighbors. Moreover, this ratio as well as real spending on education has increased substantially over the last decade. Yet, its outcomes are low, as noted above (spending and outcomes are often weakly related, see Chapter 4 in World Bank 2003). In addition to the factors mentioned above, another reason for poor outcomes could be lower instructional time- Jamaica has the lowest number of classroom hours in the above sample, partly because crime and civil disturbances force school closures. 22 58. Public expenditure on education favors the better-off, largely because of the subsidy for tertiary education. Public expenditure on education i s equitably distributed in early childhood, primary, and secondary education. However, tertiary education expenditure i s skewed, with 77 percent going to the top quintile, which i s not surprising given the enrollment patterns (see Figure 8). Per student recurrent expenditure i s much higher for tertiary education (US$3464 in 1999/00), compared to US$85 in early childhood, US$313 in primary, US$1925 in special education and US$533 in secondary education. As a result: overall education spending i s regressive, with the top quintile getting 34 percent, and the bottom two quintiles getting32 percent. I Figure8: Lorenz Curve Distributionof PublicRecurrent Expenditureby Level of Educationand by ConsumptionQuintile,2OOO 0 0.2 0.4 0.6 0.8 1 --Lineof Proprbn of Populdon Perfect Equality- - - - Preschool(N=427) -Primary (N=936) Secondary (N=662) -Tehary (N=43) Source:Constuctedfrom PIOJ-STATIN.2001 __ 59. Higher cost recovery needed in tertiary education. Given that 91 percent of tertiary students are from the top two quintiles, equality considerations are not an issue in reducing the subsidy for tertiary education. Even within tertiary education, government recovers more from teachers and community colleges than from UWI, where the students are comparatively better off. A graded increase over time in fees within the different categories of tertiary institutions will reduce inequities and generate some much-needed resources. This and other issues relating to tertiary education will be addressed in greater detail inthe forthcoming Bank report on Tertiary Education inthe Caribbean. 60. Teachers' salaries, particularly at the entry levels, have risen with public sector wages, which has distorted education spending. Wage compression has reduced the difference between the highest and lowest teacher salaries to 16-18 percent, making teacher retention difficult. Also, teacher salaries as a ratio o f per capita GDP are much higher than those that prevail inthe U S and LatinAmerica. The highpersonnel spending has led to reduced spending for instructional materials and maintenance. 61. The 2001 White Paper on education stresses life-long learning and quality education for all. It underscores the importance of early intervention to compensate for 23 a negative home environment; decentralization and school-based management; increasing allocation to education to 15-20 percent of the recurrent budget. The effectiveness of education could be increased by enhancement of certain policies and some prioritization, including: Focus on early learning and raise the functional literacy target to 100 percent. Without early learning, later education i s more costly and less effective and the functionally less literate are likely to become at risk. Increase parental involvement and awareness and student empowerment. Publicity and awareness campaigns are needed to inform parents about their role in child learning-such as in discouraging absenteeism, providing money for book rental, and in general creating a more conducive environment at home. Fathers need to be informed about their critical role in their sons' development and single mothers about good practices in rearing responsible children. Schools should systematically encourage students, involve them in school improvement, and provide them some discretionary funds to address pressing issues and thereby also get them more engaged. Expand upper secondaryeducationthrough better preparationand more places. A cost-effective way to increase school spaces would be to buy seats in private schools that target and achieve quality improvement, rather than construct new schools. Private schools can also be paid to organize compensatory education to repeaters. Improve teacher incentivesand school-basedmanagement. Teacher salaries need restructuringto reduce the salary compression, which i s perpetuated by the practice of uniform percentage increase. Empowering teachers and giving them key roles in school management andplanning would help. Reformeducation finance and address the uneven quality of schools. 1. Allocate resources based on enrollments, not teacher positions approved. Basing grants on enrollment will allow flexibility inthe use of the resources. 2. Give special grants to schools that have large needs, e.g. students reading below grade level. 3. Increase cost recovery in tertiary education. Also, the student loan scheme should draw on private rather than public resources (the current scheme has not been financially self-sustaining), given the high private returns to tertiary education, and the highmigration. IX. Crime and its Impact on Business 62. Jamaica has a strong democracy, high caliber bureaucracy and good regulatory framework. Jamaica has relatively strong democratic traditions and institutions (high level of political participation with voter turnouts of two-thirds in general elections, and a free media) and a high quality civil service (comparable to Chile, Hong Kong, France) according to cross-country surveys (see Figure 9 and Chapter 6, Table 6.1). In addition, Jamaica ranks highly in international comparisons of its 24 regulatory framework. For example, it requires 37 days to start a firm in Jamaica, compared to 34 days in Chile). Figure 9. Jamaica's International Ranking,Selected Governance Indicators 2002/2003, Average Rank (80 countries) 4 0 0 150 100 50 0 Bureaucracy Quality Law and Order Crime Costs Infrastructure Jamaica Dominican Republic OTrinidad & Tobago US. Source: See Table 6.1 I 63. However, strengths have not converted into comparable outcomes. Public satisfaction with government policies and government's ability to carry out its declared programs are below average in the cross-country comparisons. This public dissatisfaction could be partly explained by the perception that quality o f public service provision i s below average. Inaddition, infrastructure quality i s perceivedto be low. 64. Unfortunately, very poor rule of law and crime negate the positive elements inthe businessenvironment. Crime has a negativeeffect on the development of human capital, creates incentives for migration, introduces inefficiencies into the economy, undermines the work ethic, and diverts resources from investment to crime management. 65. Jamaica is amongst the most violent countries in the world. In 2000, the recorded intentional homicide rate was 33 per 100,000 inhabitants (44 per 100,000 in 2001), lower only than Colombia (63) and South Africa (52). There has been a relatively steady increase in crime (as measured by the Crime Rate Index) over the decades (although the highest year for violent crime was 1980, a period of partisan political violence), with the increase in murders over the last ten years being highly visible. These trends reflect the serious social problems associated with growing urbanization, including highlevels of unemployment, formation of gangs, creation of slums, and an escalation of drugtrafficking. 66. Violence is pervasive, and hurtsunemployed youth as well as business. While violence i s an endemic feature of Jamaican society, it i s often concentrated among the poorest in the society, and among young males, who often tend to be the victims as well as the perpetrators of violence (about 90 percent of murder victims, and more than 90 percent of the offenders are male). In a business victimization survey carried out for this report, about 42 percent of all managers felt that they were either highly likely (11 25 percent) or likely (31 percent) to be murdered at the workplace. Even in the context of the highmurder rate inJamaica, this i s an alarmingfigure. 67. Government alone spends about 3 percent of GDP on crime control. Violent crimes cost Jamaica 0.6 percent of GDP in 2001, in terms of lost production and health expenses due to mortality and injury. Including government expenditure on crime control (defense, justice and correctional services, and police), crime results in direct costs to Jamaica of nearly 4 percent of GDP (see Table 6). Given Jamaica's fiscal position, the opportunity cost of these resources i s very high, and in a less violent society at least a part of such resources could have been used for provision of critical economic and social services or infrastructuredevelopment. Table 6: The Annual Economic Cost of Crime,2001 (J$ million) I. HealthCosts 1.3 bn (0.4%of GDP) Public HealthSystem 995.7 PrivateCitizens 254.5 11. Lost Production 0.5 bn (0.2% of GDP) Mortality 194.1 Injurydue to Crime 337.2 111. Public Expenditureon Security 10.5bn(3.1% of GDP) Total I t II+I11 12.4 bn (3.7%of GDP) IV. Private Expenditureon Security 1.3% of revenue Source: Harriottet al., 2003. 68. The business victimization survey reveals the high costs that firms face. The costs of suffering crime and preventing crime are categorized as follows: Firmclosures. Firms closed for an average of 3 days due to violence in2001, and experienced losses, on average, of J$l million (J$4OO,OOO in 2000) in KMA. Looting. Of the firms looted in 2001, 57 percent had losses of less than J$lOO,OOO, 19 percent losses between J$lOO,OOO and J$500,000 and 4 percent losses between J$l million and J$5 million. Maintaining security. Private security expenditure by firms was about 2 percent of annual revenue o f the average firm (or J$l million) in2001. These costs were as high as an average of 17 percent of annual revenue for micro-enterprises with annual revenue less than J$5 million, 7.6 percent for medium firms with annual revenue between J$10-20 million, and 0.7 percent for large firms. Installing security. The cost of installingnew security devices was on average 0.3- 0.7 percent o f the annual revenue of firms. Cost of extortion, fraud, robberyhurglary and arson. Average losses due to extortion, fraud, robbery and arson were highest in manufacturing and processing firms (5.7 percent of revenue) and distribution (2.5 percent). These sectors account for most o f the firms in the less than J$5 million and J$20-50 million annual 26 revenue group, where such losses are highest, about 9 percent of revenue (see Chapter 6, Table 6.6). 69. Impact on Business Practices and Prospects. In terms of qualitative/ordinal indicators of the impact of crime, the most frequently cited was the increase inthe cost of providing security (see Table 7), reported by over 50 percent of firms. About 39 percent of firms indicated that crime has affected their plans for business expansion. Another 37 percent stated that crime has had a negative impact on their plans to invest inproductivity improvement. Given that crime appears to be such an important factor limiting the growth of firms and limiting their investment in improvement in productivity, how do firms view their economic prospects in the next three years? About 18 percent of firms in the distributive trade reported that they expect to abandon operations in Jamaica if the crime situation does not improve. This is followed by tourism (15 percent), entertainment (14 percent), agriculture (11 percent) and manufacturing and processing (10 percent). In all cases (except tourism), firms were more likely to close permanently than to relocate outside of Jamaica. This data suggest a worst-case scenario in which GDP could decline by about 7.5 percent (calculated as weighted contributions of each sector in the economy) over the next three years, assuming that the survey above represents intentions of all firms inJamaica. Table 7: Impactof Crime on Business Practice (YO) Highly Significant Somewhat SignificantlnsignificantNo ImpactTotalNumber of Significant (1) (2) Significant (3) (1t2t3) Respondents Increasedcost of security 18 17 16 51 11 38 300 Increasedcost of services purchased 4 4 10 18 17 64 291 Negative impact on worker productivity 4 4 14 22 23 55 290 Negative impact on plansfor business expansion 14 10 15 39 17 44 304 Negative impacton investmentsto improveproductivity 10 10 17 37 16 47 301 Other 5 3 5 13 14 73 79 Source: Harriottet al., 2003. 70. Coping with crime strategies imply huge implicit costs. In response to the threat of criminal victimization, individuals and firms may adjust their activities in various ways such as refusing to work on a night shift and later opening times (see Chapter 6, Table 6.5), which raise the cost of capital. These adjustments may lead to reduced economic activity and loss of employment and income. Crime may create incentives for firms to relocate their operations outside of Jamaica and for individuals to migrate. For example one of the reasons for the departure of the textile factories was the inability to operate more than one shift. Crime can also lead to loss of productive time at work owing to injuries. The periodic closure of schools reduces educational quality, particularly in the poorer areas. The impact o f crime on society goes beyond the purely material level. Crime and violence impose considerable psychological stress on the population, deplete social capital and generally reduce the quality of life of the people. 71. The determinants of violent crimes in Jamaica. Econometric analysis (see Chapter 6, Annex 6.4) shows that the determinants o f violent crimes in Jamaica are 27 similar to those encountered in other countries (for Latin America see Fajnzylber et al., 2000): (i) negative incentives or deterrence factors, such as more imprisonment, more crimes cleared up, and tougher sentencing and (ii) positive incentives such as higher per capita income, more equality, and lower youth unemployment. Policies to reduce crime should consider both dimensions of the problem: to both increase the direct costs of committing crime (the expected punishment) and its opportunity cost (the loss of income inthe formal labor market). 72. Policy Options. Better overall economic performance, in particular higher employment opportunities will reduce crime. Regarding the deterrent measures to control crime, even modest efforts will require additional resources from a country with a fiscal crisis and a stagnant economy. Based on the results of the survey, managers are unwilling to support increased taxes, but seem willing to provide financial support to specific collective solutions that directly affect them and over which there i s some direct accountability. The policy options can be grouped under four themes: Identify and measure the crime problem. 0 Strengthen official data collection on crime. 0 Conduct frequent general victimization surveys and specialized surveys on the susceptibility of crime to improve data on costs of crime, coping strategies, and to validate official data. Improve law enforcementfor crime deterrence. 0 Upgrade investigative capacity of police to improve clear-up rates for violent crimes and thereby deter such crimes, and consider special measures to investigate murders (in2001, only 42 percent of reportedmurders were cleared). Improve social prevention measures to address the root causes of crime. 0 Improve the quality of the school experience, especially for poor students. A significant fraction of the poor, and more so the males, tend to drop out of school, end up poorly educated and unemployed, and become susceptible to delinquent behavior. To address this, the disparities between different school types need to be reduced, and special efforts directed to schools that have large numbers of students reading below grade level (see section VIII). Also, school programs should be enhanced to include teaching of social and conflict resolution skills to students. Form effective partnerships between the police, business and local communities, by setting common goals and sharinginformation. 0 Build social capital such as greater trust and lower tolerance to crime and violence, especially through interventions inthe home, school and the workplace. Apply focused interventions. 0 Target high crime urban areas, especially the Kingston Metropolitan Area, to reduce the impact of crime on the business community using a combination of measures suggestedabove, as was done inthe case o f Boston (see Chapter 6, Annex 6.8). 28 0 Target youth at risk with specific youth development programs in addition to the schooling focus mentioned above. X. ImprovingJamaica's International Competitiveness 73. Jamaica is a very open economy, with few trade barriers. It introduced capital account convertibility in 1991. It undertook significant tariff reform after 1991 which reduced the average tariff from an already moderate level o f 20.3 percent to 8.9 percent in2002. In 1991, it eliminated all quantitative restrictions and licensing requirements for exports and imports. Recent work by Dollar and Kraay (2001b) shows Jamaica as a `globalizer', meaning that it i s in the top one-third of a group of 72 developing countries in terms of their increase in trade relative to GDP between 1975-79 and 1995-97. The study shows that the weighted average growth rate per capita of globalizing countries rose from 3.5% to 5% between the 1980s and 1990s, while that o f the non-globalizing ones rose from 0.8% to only 1.4%. However, in Jamaica's case, the positive impact of trade and other structural reforms has been more than offset by other factors, resulting in disappointing GDP growth as discussed in Section V, Chapters 2 and 7, and Loayza et a1 (2002). 74. Jamaica's competitiveness declined in the 1990s, which was reflected in loss of world export share and a lower export share of output. Figure 10 shows that Jamaica's share of world merchandise exports fell steadily from 0.036% in 1994 (and similar figures in the early 1990s) to 0.024% in 2001, a fall o f one-third. This was accompanied by an even larger proportionate decline in the share o f exports in GDP (in nominal terms), from 32% to 19%. If GDP growth was disappointing in the latter half of the 1990s, export growth was even more so. After doubling between the mid-1980s and end-1980s, merchandise exports have fallen since 1995. Manufacturing employment has declined since 1997 and manufacturing exports since 1995. Agricultural output and exports peaked in 1996, and have generally declined since then. Even the growth in tourist receipts slowed down in the second halfo f the 1990s. 75. The weak performance of exports and goods i s closely linked to the behavior of the real exchange rate (REER), which is often itself considered as an indicator of competitiveness (as well as other factors making Jamaica `high-cost', see below). The REER (CPI-based), appreciated sharply from 1992-1998, with significant reversal of this after January 2002, and especially in 2003. The wage-based REER has appreciated even more than the CPI based REER, arising from the large wage increases over 1992-1998. Figures 10 and 11show that the link between the REER and export shares i s strong, and demonstrate the sensitivity of exports to the exchange rate, contrary to what i s sometimes believed inJamaica. 76. An appreciated exchange rate affects the pattern of growth. With an appreciated exchange rate, resources tend to flow to the more profitable non-tradables sector, leading to higher imports and lower exports. Also, overvalued exchange rates tend to affect growth through reduced productivity, since export and import competing sectors often see the most rapid productivity advances. O f course, an appreciated real exchange rate also stimulates imports, and in Jamaica's case the lower cost of food 29 imports was probably a factor not only in depressing agricultural output but in reducing poverty. Figure 10: As its REER appreciated, Jamaica's Share in World Exports Fell i::: CARICOM/ Venezuela agreement NAFTA 140 - ,,,~~, (1993) IUUU, 0.040 130 - Share inworld merchandise \ + REER Index 1 120 - (19!X=loo) t0.034 1 110 (Left Axis) - 0.032 loo - 0.030 9 0 - 0.028 8 0 - 0.026 70 Capital A/C Converblitv- 0.024 - (1991) Financial Crisis (1995) ~ 6 0 7 Figure 11: and its Share of Exports in GDP declined ... 1 T7' i 130 i REER 1I 6 5 ~ Source: International Financial Statistics, IMF. 77. The 1992-1998 appreciation of the real exchange rate made domestic adjustment to the tariff reduction more difficult. For example, after 1992, when tariffs were reduced as per the CARICOM agreement, the exchange rate was appreciating. A depreciation of the exchange rate during that period would have softened the competitive impact on the domestic sector. An appreciated exchange rate would also 30 help to explain the increased pressures for protection (and the levying of increased stamp duty) since 2001 from the producers of agro-products such as poultry, meat and eggs. 78. The real exchange rate has depreciated in 2003, as a result of a substantial nominal exchange rate depreciation without significant pressure on inflation. Given the rising current account deficits (CAD) since 2001, as well as the worsening fiscal situation, pressure had been building up on the exchange rate. In the event, the nominal exchange rate did depreciate significantly in 2002 and especially in the first half of 2003. Between January 2002 and July 2003, the nominal effective exchange rate depreciated 24 percent, consumer prices rose 15 percent, and there was real depreciation of 18 percent. This behavior of the real exchange rate after depreciation is in line with recent research. According to a number of studies including one recently published in the Bank of Jamaica Research Papers (McFarlane, 2002), the pass-through factor from changes in the exchange rate to inflation has declined in the 1990s. This decline could arise from a) the large gap between actual and potential output; b) years of low inflation, which themselves help to engender lower inflationary expectations; c) low current and projected world inflation; and d) the decline in protection in the 1990s, which has left a strong competitive pressure on prices. 79. The survey of exporting firms done for this report finds that export competitiveness has also been hurt by high wages, high crime, difficulties in accessing inputs, and high cost of utilities, all adding up to a high cost economy. Companies had been adversely affected by the wage increases, which exceeded productivity increases every year between 1992 and 1998, save 1994 (see Section V and Chapter 2). Highcrime has imposed large overhead costs on companies (see also Section IX)-in agro-processing, increasing costs are incurred to ensure no drug contamination. Security costs can be as high as 5 percent of sales. Crime has also increased substantially the costs of night shifts in call centers and textiles, reducing their competitiveness with countries that work two or three shifts. Inthe all-important tourism industry, crime reduces the potential number of visitors and creates a need for higher costs in marketing and security. The exporting sector, as also the rest of the economy, i s handicapped by slow customs procedures, which increases the cost of imported materials, including bottles and packaging materials. Small firms and start-ups have difficulty in accessing credit, since banks consider them too risky. Also, highcost and unreliable utility services have led firms to invest in expensive alternatives like stand-by electricity production. 80. Many of these problems are reflected in the decline of the apparel sector after 1995, which at one time had promised much, but whose exports fell off from US$533 million in 1995 to US$289 million by 2001. In the last five years, it has shed over 10,000 workers. Costs relating to labor, security, energy, along with an appreciated exchange rate, have meant that Jamaica has lost out to competitors like Haiti, the Dominican Republic, Honduras and El Salvador, to name a few. 81. The adverse environment has affected even tourism, one sector that has done relatively well. Jamaica's most successful exports have been based on exploitation of natural resources, especially tourism and bauxite. Tourism, for example, continues to trade on its endowments of sun, sand and beaches. However, tourism growth has slowed 31 since 1995 (2.4 percent annual increase in dollar receipts over 1996-2001 compared to 9 percent over 1991-95), and Jamaica has lost market share to the Dominican Republic, Cancun and Aruba. The hotel business has been hurt by the increase in wages, the exchange rate appreciation (especially in the European market), harassment of tourists, and highsecurity costs. 82. The scenario for export demand is largely favorable, in spite of erosion of preferences. Services have grown from 33 percent to 57 percent of GNFS exports over 1980-2001, mirroring similar orders of increase in world trade patterns. Jamaica's GDP i s increasingly dominated by services (such as tourism and financial services), thus producing a positive congruence between world demand growth and Jamaica's production structure. In other areas including manufactures, Jamaica needs to worry less about growth areas in world trade, since it will always be a niche player and so can look to its own strengths. Finally, even though erosion of preferences i s likely to hurt exports of sugar, bananas and apparel, these constitute a relatively small 11.3 percent of GNFS exports. In any case, Jamaica often does not fulfill its quota even in preferred commodities, demonstrating that its competitiveness problems are largely domestic. Other issues relating to ongoing developments in world trade in the context of Caricom's negotiations in the WTO, FTAA and with the EU will be addressed in the Bank's forthcoming report on competitiveness and trade issues inthe Caribbean. 83. Policy options. Increasing exports and trade as well as FDIinvolves providing a supporting environment. In general, FDIcannot be expected to create competitiveness, and in fact foreign investors will invest in sectors and niches that they view as competitive. Improving competitiveness will involve: Ensuring that the recent gains and future potential gains in exchange rate competitiveness are preserved. Recent trends inthe exchange rate indicate that this i s possible. It will also require moderate nominal increases in wages in Jamaican dollars. At the same time, maintenance of credible fiscal policies will be required in order to prevent the possibility of an excessive correction inthe exchange rate. Eliminating the stamp duties that are levied on selected imports, especially food, so as to limit the price increases that accompany exchange rate depreciation. Reducing crime, which i s a major cost for exporters (Chapter 6). Improving the credit climate for smallcompanies and start-ups (Chapter 3). Reducing the cost and providing better coverage of water and sewerage services, improving roads, especially rural roads, and the reliability of power supply, and ensuring that all these are fully financed by user charges, Le., by levying and increasing tolls and user fees on existing and upcoming infrastructure facilities. Improving access to imported inputsby makingcustoms procedures more efficient. 32 PART 11: MAINREPORT CHAPTER 1: GROWTHAND POVERTYREDUCTIONINJAMAICA I. INTRODUCTION 1.1 Poverty in Jamaica declined substantially in the latter half of the 1990s, from an estimated 27.5 percent of the population in 1995 to about 17 percent in 1999. Paradoxically, this decline occurred despite a major financial crisis and a small annual decline in measured GDP after 1995. The decline in poverty i s probably due to several factors particular to the period: (a) output probably has grown somewhat faster than measured GDP; (b) the informal sector has provided incomes for many people who could not find formal sector work (see Chapter 2); (c) inflation, a "tax" on the poor, has fallen sharply; and (d) the relative price o f food has fallen. In addition, rising real wages and remittances may have helped reduce poverty. However, rising real wages can cut both ways, because these, along with the appreciating real exchange rate and crime, have tended to reduce demand for labor in the formal private sector. Remittances, which have grown sharply in dollar terms, though not relative to GDP, have probably kept people out of poverty, but not contributed much to its decline. 1.2 Unfortunately, it i s unlikely that the factors that reduced poverty in the latter half of the 1990s will continue to operate; indeed, the slowing impact of these factors may explain why the incidence of poverty has remained roughly constant since 1998. 1.3 A sustained reduction in poverty in the future is likely to depend on sustained growth in the Jamaican economy as well as the implementation of pro-poor policies. As cross country evidence demonstrates, on average poverty declines with growth, and poverty can be sustainably reduced with policies that encourage private sector demand for labor, improve empowerment of the poor and access to education, health and social services. Rural poverty will need special attention, since it will depend not just on improved growth in agriculture, (which will be helped by a more competitive exchange rate), but wider growth inthe rural sector and better access to social services. 1.4 The chapter i s divided into six sections. Section I1provides a brief review of poverty trends, identifying four distinct stages. Section 111presents a profile of the poor in Jamaica and the factors linked to poverty, such as large households and households headed by females, which are characteristic not only of poverty in Jamaica but in most countries. Section N examines the issue of rural poverty vs. urban poverty and finds that the rural poverty incidence i s more than three times higher than in Kingston. Section V discusses the paradox of poverty reduction despite no measured growth in the latter half of the 1990s, examining the issues of the measurement of GDP and poverty as well as analyzing the possible impact on poverty of the reduction in inflation, the falling relative price of food, the growth in remittances and the growth inthe informal sector. Section VI summarizes and presents some suggestions for policy. 11. POVERTY INCIDENCEAND INCOMEINEQUALITY 1.5 In 2001 the Jamaica Survey of Living Conditions (SLC)' reported that the incidence of poverty was 16.8 percent, down from 18.7 percent in 2000. The incidence of poverty in the rural areas, 24.1 percent in 2001, also declined, albeit marginally, from 25.1 percent in 2000. In the Kingston Metropolitan Area (KMA), where the poverty i s well below the national average, the incidence of poverty fell to 7.6 percent, down from 9.9 percent in 2000. Box 1.1: Measurement of Poverty inJamaica Since 1989, the Government of Jamaica has been estimating poverty annually, based on a Living Standards Measurement Survey (LSMS), conducted by the Statistical Institute of Jamaica (STATIN). The survey uses a multistage stratified random sampling method to select dwellings of households in the Enumeration Districts (EDs). STATIN collects data by direct interview, on food and non-food consumption from a sample of representative households. The absolute poverty lines used in estimating poverty in Jamaica are based on the food energy intake method and also factor in consumption of basic non-food necessities. The minimum food consumption basket was determined by the Ministry of Health based on a dietary survey of the bottom two quintiles of the population. The survey was used to develop a representative food basket that takes into account the minimum needs for energy, calcium, protein and iron. The minimum requirement was based on a PAHO/WHO recommended standard of 11.700 kcals for membersof a reference familv of five. 1.6 Broadly speaking, poverty in Jamaica seems to have gone through four phases (see Tables 1.1 and 1.2 and Figure 1.1). Inthe first phase, from independence until the first major oil price shock in 1973, it seems likely that poverty declined along with the strong growth in aggregate income. Between 1966 and 1973, the Jamaican economy grew at an average rate of 5 percent per annum, driven by the boom in bauxite and tourism, as well as fairly strong growth in a highly protected manufacturing sector. Duringthis period, inflation averaged a moderate 7.5 percent per annum. Inthe second phase, from the mid 1970s to mid 1980s, it seems likely that poverty rose, especially in the mid 1980s. This period was marked by a second oil price shock in 1979, higher external interest rates, higher inflation and lower growth in Jamaica. A minimum wage policy was implemented and may have helped to double the share of the bottom quintile in consumption over 1971-1975. The increase in poverty towards the end of the period probably reflects the difficulty of sustainingpoverty reduction in an environment of weak growth and highinflation. 1.7 The third phase, from the late eighties to 1998 reflects a trend decline in poverty interrupted in 1991 and 1992 by inflation and rising food prices, then again in 1995 and 1996 by the financial crisis (See Figure 1.1). A deepening of the structural adjustment process and the deregulation and liberalization of the economy marked the beginning o f this period. The sharp rise inpoverty in 1991probably reflects not only the slow growth of income, massive inflation and devaluation, but also the removal of cross subsidies on ' Published jointly by the Statistical Institute of Jamaica (STATIN) and the Planning Institute of Jamaica (PIOJ) 34 food imports. However, the elimination of the Jamaica Commodity Trading Corporation monopoly, the removal of import food subsidies, and the real devaluation created greater incentives for domestic agriculture, which grew at an average rate of about 10 percent over the period 1992 to 1994. The possible explanations for the trend decline in poverty are discussed in Section V: the possible underestimate of growth and the contribution of the informal sector; the reduction in the inflation "tax", which largely falls on the poor; the reduction in the relative price of food related to trade liberalization and the appreciation of the real exchange rate, and the rise of real wages. The changes inpoverty during this period appear to be driven by large changes in the middle of the distribution of consumption, and not by changes around the poverty line, according to Handa et a1 (2001). The food stamp program has limited extreme poverty and contributed to improving the welfare of the poor. Share of the poor Index of real per capita consumption Percent of Total Consumption (1988 =loo) Bottom Next All Bottom Next Year Quintile Quintile Jamaica Quintile Quintile 1958 2.2 6.0 83 34 50 1971 2.0 5.0 110 41 56 1975 4.1 9.0 123 94 112 1984 4.2 9.5 102 80 98 1988 5.4 9.9 100 100 100 1.8 In the fourth phase, from 1998 to 2001, poverty has leveled off. The lack of further gains may reflect the leveling off of the factors that contributed to the decline in poverty noted above and discussed in Section V. Figure 1.1 Jamaica: Poverty HeadCount (% of population) 50 7 Poverty= -1.65time t 36.66 40 - 30 - 20 - Source:Survey of LivinqConditions,PIOJ-STATIN,various issues ~ *Ezmanari and Subbarao (1999) suggest that in the absence of a food stamp program, the poverty gap index in Jamaica would have been much worse in 1990-91. They also present evidence suggestingthat in this periodthe programwas most effective inhelpingthe elderly poor andfamilies with young children. 35 1.9 In 2001, the poorest 20 percent of the population had 6.2 percent of national consumption, while the wealthiest 20 percent had 45.9 percent. This distribution of consumption would suggest Jamaica i s a country with medium inequality, with less income inequality than most Latin American countries but more than most industrial countries. As shown in Table 1.1, there has been a significant increase in the share of consumption of the poorest quintile of the population since 1975. However, inequality, as measured by the Gini coefficient of consumption in the SLC, has not changed much in Jamaica over the last decade, although poverty has fallen significantly and GDP growth has been negligible.3 Table 1.2: Povertvand Social and EconomicIndicators 111. WHO ARE THEPOOR? 1.10 InJamaica, the profile of the poor in the more recent SLC suggests that several interrelated factors are linked to poverty - large households, households headed b y females, low educational attainment, unemployment, and dependence on rural employment - factors that are associated with poverty in most countries. About 23 percent of Jamaica's children live in poverty (PIOJ-STATIN, 2001) and they account for about half of all people living in poverty (UNICEF and PIOJ, 2000). In Jamaica, poverty also appears to be strongly correlated with social factors including: teenage pregnancy; single parenting; drug abuse; domestic violence; child abuse and delinquency, though these associations are more often the result o f poverty, than its cause. 1.11 Individuals with the highest incidence of poverty are those in relatively large households, in all surveys from 1989-2001. Econometric work usingdata for 1999, 1997 The lack of change in the Gini coefficient may reflect its insensitivity, and the fact that the same Gini can apply to more than one income distribution. For example, if the status o f the poor improves, but the status of the middle class deteriorates, then the Gini could remain unchanged. 36 and 1993, finds that those in larger households have a greater probability of being poor (Benfield, 2002). The link between large households and poverty i s found in most countries. This probably reflects the fact that larger households have more dependents, which more than offsets any economies associated with household size in the use of durable goods. InJamaica in 2001, the mean household size in the poorest quintile was 5.2, compared with 2.3 in the wealthiest. The geographic distribution for the 2001 JSLC showed the mean household size was highest in the rural areas at 3.62 and lowest in the Kingston Metropolitan Area at 3.19. The mean number of children was 1.27 in rural households compared with 0.96 for urban households. There i s also a vicious cycle in that the poorer and rural households tend to be larger because they are less educated about fertility and contraception and have less access to health facilities, and larger household size tends to makes the household poorer. 1.12 Female-headed households now account for about two-thirds o f the households in poverty, and generally show a higher incidence of poverty in all the surveys since 1989. (The proportion of households headed by females has varied from 42 to 45 percent between 1990 and 2000). In 2001, per capita consumption in female-headed households (J$77,850) was nearly 10 percent lower than in male-headed households. The higher incidence o f poverty in female-headed households i s also related to the fact that female- headed households tend to be larger than those headed b y males. In2001, the average household size of the female-headed household was 3.6 persons compared with 3.2 persons for the male-headed household. 1.13 As is the case with other countries, the higher poverty incidence of households headed by females i s partly explained by the correlation between households headed by females and single income households. Greater poverty incidence in female-headed households also probably reflects the higher open unemployment rates among women. In 2001, the unemployment rate among females was 21 percent, more than twice the rate for males (10.3 percent). The situation i s little changed since 1990, when the female unemployment rate was 22.5 percent and the male rate 9.1 percent. 1.14 In Jamaica, the education of the household head is also a strong determinant of poverty, as in most countries. The SLC data suggest that while educational achievement i s weak overall, the poor tend to have even less education. For example, the data for 2001 showed that 86 percent of the poor do not possess any academic qualification, compared to 52.3 percent of the wealthiest quintile, despite the progress since the early 1990s. Current data do suggest some hope - access to education i s almost universal with 99.5 percent enrolment at the primary level (6-11 years), and 96.4 percent at the lower secondary level (12-14 years) -but it will take a while for this to work its way through the labor force. The mother's education has a significant impact on both grade attainment and current enrollment, while father's education i s more important in determining current school enrollment than grade attainment (Handa 1996b). This creates the risk of a vicious cycle of low parental education and poverty leading to low education and poverty o f the children. Also, poorer students get tracked into lower quality schools, which limits the benefits of education (see Chapter 5). The current data for Jamaica raise the concern of a cycle of chronic poverty, since poverty rates drop significantly only after the head of the household has completed the 2nd cycle secondary 37 school, and family income i s the most consistently significant determinant of high school enrolment (Handa 1996b). 1.15 For policy purposes, another important dimension of poverty i s the vulnerability of those close to the poverty line. Consistent with the general decline in poverty, vulnerability appears to be somewhat less in 2000 than in 1993. According to data from the SLC in 1993, of the population at or above the poverty line, 37.5 percent had per capita consumption between 0-25 percent above the poverty line. In 2000, that figure had fallen to 31.4 percent. Of the population below the poverty line, in 1993, 15.1 percent had per capita consumption 0-20% below the poverty line. By 2000, the figure had fallen to 10.1percent. Regarding the sensitivity of poverty to the choice of the specific poverty line, Handa et al (2001) used Kernel density estimates of per capita consumption to analyze the behavior of consumption distribution for several periods between 1991 and 1998 and conclude that poverty headcount rates are not sensitive to the specific choice of poverty line. IV. RURALVS. URBANPOVERTY 1.16 The incidence of poverty inthe ruralareas at 24.1 percent i s more than three times higher that in Kingston (Table 1.3). Poverty has generally declined over time in both urban and rural areas, but at a much faster rate in the Kingston Metropolitan Area. As a result, the incidence and the relative incidence of poverty are higher in the rural areas. The stubbornness of poverty inthe rural areas is reflected by the fact that in2001, despite an almost 17 percent increase in per capita consumption in the rural areas, the incidence of poverty declined by only 1 percent (PIOJ-STATIN, 2001). Nonetheless, urban poverty tends to receive more attention from the government due to concerns that it may be associated with higher crime, violence, and other anti-social behavior that contribute to perpetuating chronic poverty b y limiting access to social services including education (closing o f schools) or restricting employment opportunities. This i s partly due to the fact that urban poverty tends to be concentrated in inner city areas. 1.17 The incidence of rural poverty also exhibits more volatility-over 1991-2001, the standard deviation of rural poverty was 10.8, versus 6.1 for urban poverty. A cursory examination of the data suggests that when agricultural GDP growth has been high (above 10 percent) there has been a corresponding sharp reduction in the incidence of rural poverty. For example, in 1992 and 1993, when the agricultural sector grew b y 13 percent and 10 percent respectively, the rural headcount ratio fell from 57.2 in 1991 to 42.2 in 1992 and 29.6 in 1993. Thus, rural poverty dropped sharply after subsidized food imports were eliminated in 1991 and agricultural production increased, but then has fallen only slowly as agricultural production fell. In 2000, when agricultural GDP contracted b y 10.9 percent, rural poverty rose from 22 percent in 1999 to 25.1 percent in 2000. The volatility in the level of rural poverty is related not only to policy changes but also to the fact that the welfare of many rural people i s tied directly or indirectly to the weather, rain-fed agriculture and seasonal work. Given the duality of agriculture, it i s likely that small farmers constitute a large proportion o f the rural poor. 38 1.18 Notwithstanding the above, the overall correlation between growth in agriculture and rural poverty is low (0.27), suggestingthat the performance of the agricultural sector may be only a small part of the puzzle of high rural poverty. At the very basic level, this suggests that rural poverty in Jamaica cannot be fixed by only focusing on agriculture or even domestic agriculture. To be sure, much can be achieved by taking actions to increase the productivity in agriculture through improvements in research and extension as well as improving road and irrigation infrastructure. However, many o f the rural poor are those left behind, who are hard to reach, including unemployed youth who are not engaged in agriculture. Table 1.3: Poverty in Rural and Urban Areas (percentof population) a: Ratio of rural povertyto KMA poverty. Source: Jamaica Survey of Living Conditions, various issues. V. POVERTYREDUCTIONWITH NO GROWTH: "THE PARADOXOFTHE 1990s" 1.19 Poverty has declined over the 1990s despite negligible or even negative measured GDP growth, as mentioned above (see Figure 1.2). The decline in poverty appears whatever poverty metric i s applied to the SLC.4 What, therefore, has been responsible for the marked reduction in poverty over this period? The following subsections discuss possible explanations for the decline in poverty over the 1990s: measurement errors in GDP and the SLC, the informal economy, real wage trends, falling inflation, falling relative prices of food, and the possible role of remittances. MeasurementIssues 1.20 Questions have been raised regarding both the measurement o f GDP growth and the measurement of poverty. Regarding the measurement of GDP growth, some evidence suggests that both consumption growth and overall GDP growth may be underestimated. (see Chapter 2). For example, the consumption of meat and fish grew at an average annual rate of 6.4 percent between 1995 and 2001, compared with a much slower growth of 0.7 percent per annum in the previous five years; household electricity consumption also grew (see Chapter 2, Box 1). STATIN has alluded to the fact that such underestimation may be attributed not to the methodology used by STATIN but possibly to weakness in the sources of input (some from surveys) to the National Income estimates. If GDP growth has been underestimated, then the paradox may be somewhat less. If GDP growth i s being consistently underestimated by, say, 1.5 percentage points The poverty gap and the severity of poverty also declined (Sanchez-Paramo and Steele, 2002). 39 per year during the latter half of'the 1990s, even considering the financial crisis years of 1996 and 1997, GDP growth per capita would average about 0.3 percent between 1995 and 2000. Assuming an elasticity of -1.0 of change in the head count with respect to change in GDP growth per capita, poverty would decline, on average, by about 0.3 percentage points per year. However, this would still leave the head count poverty index well above 20 percent in 2000. Figure 1.2 Poverty (%), Annual Inflation (% p.a.) and Annual GDP Growth (% p.a.) 100, Ij T 2o 20 0 1z+Head m 0 7 zm N m m m m d LD W m m 0 7 m 0 7 N 0 0 N 0 7 m m r.m m 7 z z z z Count Index +Inflation +GDP Growth (right axis) 1 Source: SLC, PIOJ-STATIN,various issues; ESSJ, STATIN, various issues. 1.21 Questions have also been raised regarding the accuracy of the JSLC in the measurement of poverty, particularly in 1997 when the JSLC reported a significant fall in the level of poverty, from 26.1 percent of the population in 1996to 19.9 percent in 1997.5 Correspondingly, the ratio of consumption in the SLC to consumption in the national accounts rose from 66.7 percent in 1996 to 85.2 percent in 1997, the highest figure between 1990 and 1997 (1997 SLC and 2001 National Income and Product). However, STATIN explicitly denies any change in the methodology for the JSLC. Of course, one could interpret the sudden change to over-estimation of poverty before 1997 as well as underestimation in 1997. Nonetheless, there does seem to be a fall in poverty from the early 1990s to 1996, albeit with poverty rising after 1994, as might be expected in a macroeconomic and financial crisis. After 1997, poverty incidence falls again and then levels off, varying between 16 and 18 percent between 1998 and 2002. Overall, poverty does seem to have declined. This i s in accord with other estimates of poverty, which are generally higher than the JSLC estimates but also show a decline in poverty between 1995 and 2000 (See Benfield, 2002, for some alternative estimates). The InformalSector, a residual source of employment 1.22 The informal sector, including the drug industry, may be a source of underestimation of GDP (see Chapter 2) and has been a residual source of employment. Employment in the informal sector (as roughly proxied by own account workers, see TheJamaica Gleaner,October 30, 1999. 40 Annex Table 2.7) was roughly constant over the latter half of the 1990s. Although this i s not a strong performance, it i s much better than total private employment, which declined about 7 percent during the same period, or overall employment (including the public sector), which declinedby about 3 percent. Reflecting the above trends, the share of own account workers in the employed labor force rose from 34.4 percent to 36.4 percent over 1995-2001, a figure that rises to 40.2 percent if public sector employment i s excluded. Generally speaking, the informal sector tended to increase faster than the formal sector over the last three decades (Witter and Kirton, 1990; IADB, 2002). The relative growth of the informal sector may reflect the decline in demand for labor outside the public sector, reflecting the slow growth of the formal economy and in its demand for labor, discussed above. The recent changes in informal sector employment and private employment are positively correlated, suggesting that both are determined by the same factor, for example, aggregate demand. However, the declines in informal sector employment are generally much less in absolute size than formal private employment. These figures suggest that informal employment has helped some workers avoid poverty. To account for the fall inpoverty, it i s likely that informal employment and earnings from the informal sector would have to be underreported, which may be the case, as discussed in Chapter 2. However, the general trends suggest that informal employment, as reported, cannot account for the large fall inpoverty duringthe 1990s. 1.23 Informal sectors workers tend to have fewer years of schooling and earn less than formal sector workers. A recent study finds that, on average, informal sector workers earn about 36 percent less than workers in the formal sector (IADB, 2002). However, these workers pay no direct taxes, or licensing fees, reducing the difference in net income between the formal and informal sectors. For example, an informal taxi avoids the costs of operation associated with registering with the Transport Authority and purchases insurance for a private vehicle rather than insurance for a public passenger vehicle, which may be significantly higher. Thus, the high cost of being in the formal sector i s another factor leading to the growth of the informal sector (see Chapter 3). RisingRealWages butFallingEmployment 1.24 Another possible explanation of the decline in poverty i s the increase in real wages (Table 1.4), though that increase has probably also contributed to the loss of private sector employment, particularly among females. Nominal earnings rose by 107 percent between 1995 and 2000, outstripping the CPI index, which increased by 71 percent. Inthe early 1990s, with the liberalization of the current account and the removal of exchange rate controls, the country suffered a series of severe foreign exchange shocks and exchange rate depreciations,6 accommodated by loose monetary policy, all of which led to high inflation. Strong trade union pressure forced many employers into wage settlements above the high inflation rates and led some companies that could not afford the highwage settlements to fire workers, go out of business, or limit their new hiring. For example, the average annual exchange rate moved from J$12.12/US$1.00 in 1991 to J$22.96/uS$1.00 in 1992. 41 1.25 In 1995, the Government embarked on a policy of disinflation, underpinned by a tight monetary policy based on base money targeting. Inflationfell from 25.6 percent in 1995 to 9.2 percent in 1997 and has remained in single digits since then. However, backward-looking labor contracts and rising public sector wages continued to raise wages in excess of inflation and real wages in large firms and the public sector rose significantly. However, employment shrank in the formal sector outside the government as a result of the rising real wages, as well as the loss of competiveness in goods production due to the appreciating real exchange rate and the cost of crime (see Chapters 2 and 7). Over the latter half of the 1990s, formal private employment declined by about 7 percent, and female employment declined by over 30,000. In 2002, employment apparently rose, along with GDP growth, but this was almost all due to increased public sector employment-mainly short-term contracts-and there are also problems of comparability of the data (see Chapter 2). In sum, the net effect of the rise in real wages on the overall poverty headcount i s difficult to establish, not only because many formal sector employees may already have been above the poverty line, but also because of the potential negative effect on employment, particularly new hires and females, who are more likely to be poor. Table 1.4: Movement in AverageWages and Earnings Comparedto Increasein CPI 1995 September 989.0 25.3Yo 4,246 18.6 Yo 2,567 10.8Yo 1996 September 1084.5 9.7 Yo 5,367 26.4 Yo 3,191 24.3 % 1997 September 1175.8 8.4 % 5,981 11.4% 3,369 5.6Yo 1998 September 1276.3 8.6 Yo 6,751 12.9 Yo 3,747 11.2% 1999 September 1349.3 5.7 Yo 7,408 9.7 Yo 4,150 10.7 % 1.26 The national income data of the national accounts data corroborates the picture of improving income of formal sector workers, at the expense of profits, but also, surprisingly, a rise in the average income in the informal sector. As a percentage of GDP, compensation of formal sector employees increased from 41 percent in 1994 to a peak of 49.2 percent in 1999, before declining slightly in 2000 and 2001. At the same time, operating surplus, as a percentage of GDP, fell from 38.9 percent in 1994 to 29.2 percent in2001 (Table 1.5). 42 Table 1.5: Factor IncomeShare Compensationof Compensationof Operating Operating NominalGDP Year Employees, Employees, Surplus, Surplus, Growth, Percent increase percentof GDP Percent Percentof Percentper increase GDP year 1999 7.8 49.2 4.5 28.5 7.6 2000 10.8 48.7 13.4 28.9 11.9 2001 7.8 48.3 10.0 29.2 8.8 The FallingInflationTax: A Pro Poor Policy 1.27 Another factor that may explain the reduction in poverty, despite Jamaica's slow growth i s the sharp reduction in inflation, which Dollar and Kraay (2001a) have called a "super-pro-poor" policy. Many other authors also have argued that keeping inflation low i s beneficial to the poor.7 This i s not surprising, since high inflation taxes the limited assets of the poor, which are mostly in currency, much more than it taxes the assets of the middle and upper classes.* 1.28 In Jamaica, there seems to be a strong correlation between high inflation and increased incidence of poverty (see, for example, King and Handa, 2000). Jamaica's inflation jumped from 29.8 percent in 1990 to 80.2 percent in 1991, due, among other things, to a sharp depreciation of the exchange rate, accommodating monetary policy, and the decision to allow the utilities and the Jamaica Commodity Trading Company to pass on the real cost of goods and services to consumers. The reduction in the subsidy on imports and the removal of price controls were in keeping with the strategy to liberalize the economy. In addition, the implementation o f the General Consumption Tax in 1991 may have also contributed to the sharp rise in prices. During that period, the headcount poverty ratio increased dramatically from 28.4 to 44.6 percent, as shown in Figure 1.2 and Table 1.2. With the fall in inflation, poverty also fell. Inthe latter half of 1995, the 'See, for example, Bruno and Easterly (1995). Romer and Romer (1998)have found that the income share of the poorest quintile i s inversely related to inflation, using panel data. Bulir (1998) found that the effect of inflation on inequality i s not linear-reductions in inflation from hyperinflationary levels lower income *inequality much more than further reductions to low inflation levels. The high inflation tax was partly offset by the increased availability of US dollars in Jamaica after liberalization. However, the use of Jamaican dollars, which are subject to loss of purchasing power during inflation, continues to dominate the day-to-day transactions by the poor. 43 government intensified its stabilization program. Since 1997, Jamaican inflation has been reduced to single digits (Table 1.2), and at the same time, poverty has fallen. Statistically, there i s a highcorrelation between the poverty head count and inflation. 1.29 As noted above, in the last few years, the reduction in poverty has leveled off. Partly this may reflect the leveling off of inflation at low levels. Declines in inflation from its already low levels are unlikely to generate much additional reduction in the inflation tax, and thus not have much additional effect on poverty reduction. The Fall inthe Relative Price of Food 1.30 Relative prices of food also have fallen, contributing to the reduction in poverty because of the large role that food plays in the budget of the poor (Table 1.6). According to the 2001 SLC, mean annual per capita food consumption constituted 55.7 percent of the budget of the poorest quintile compared to 36.6 percent o f the wealthiest. The opening of the economy, the sharp devaluation, and the elimination of the monopoly and subsidies on food imports in the early 1990s, initially led to a rise in the relative price of food. However, since 1995, the relative price of food has fallen by about 10 percent. This fall reflects lower prices of primaries worldwide, the real appreciation of the exchange rate and the decline in trade protection. The fall in the relative price of food has reflected very clearly in the budgets of the poor-the share of the poorest quintile's household budget spent on food declined from 66 percent in 1991 to 55.7 percent in 2001. On average, the fall in relative food prices after 1995 would have helped to reduce and then stabilize the poverty ratio, especially once there were no further gains inpoverty reduction to be had from reduction of overall inflation since 1997. Table 1.6: Jamaica CPI Annual Index and RelativePriceof Food The estimated equation is: Poverty HeadCount = 16.5 + 0.37** Inflation "t" statistic (7.5) R',,. =0.90 where ** signifiesa variable is statistically significant at the 95 percent level or better. The jumps in poverty and inflation in 1991 contribute to the significance of the result, but even excluding 1991the relation between inflation and poverty is significantly positive. 44 The Roleof Remittances 1.31 Waves of migration since the early sixties have resulted in a significant Jamaican diaspora in North America and Europe (mainly England). Strong family ties in Jamaica including dependent parents and children as well as demand for retirement real estate in Jamaica have resulted in a significant inflow of private remittances, which reached nearly US$1 billion in 2001 (see Table 1.7). Remittances are really the flip side of the massive brain drain and skills migration, which Jamaica has experienced over the past several years. In Jamaica, it i s estimated that remittances from overseas average about US$700 per year for the families that receive them. Internal remittances, mainly from urban centers to rural areas are also important. Internal remittances average about J$3,000 to J$3,500 or about US$50-US$70 per transaction and tourist centers figure prominently as starting points for these flows. This income support from remittances may in fact be the means by which many families have remained above the poverty line. In the Consultations with the Poor (1999) it i s reported that in some rural areas, 40 percent of households derive significant financial support from relatives working abroad or in one of the major cities. 1.32 Remittances are a significant part of the coping strategy o f the poor, and may be a significant factor in reducing vulnerability but it i s less clear that they explain the sharp fall in poverty after 1995. Between 1995 and 2001, private remittance inflows to Jamaica grew at an average rate of nearly 8 percent per year in U S dollars. The increase may be due not only to a rise in migration, but also to the increased efficiency and security of transferring money to Jamaica that resulted from the rapid growth of the remittance companies in the mid-nineties. However, remittances have risen only about 1.5 percentage points of GDP over 1995-2001-the difference between the figures in US$ and those relative to GDP reflects the real appreciation of the Jamaican dollar. In fact, remittances actually fell by about 2 percentage points of GDP between 1995 and 1998. Hence it seems unlikely that (recorded) remittances from overseas can explain the sharp fallinpoverty. Table 1.7: PrivateRemittanceInflows (US$ millions) Source: Bank of Jamaica 45 VI. SUMMARYAND ISSUESFORTHE FUTURE 1.33 The characteristics of poverty in Jamaica are similar to poverty in most developing countries. The poor are more likely to be members of larger households, in female-headed households, have less education, and employed in the rural sector- agriculture or fishing. 1.34 Poverty in Jamaica has fallen substantially over the 1990s, despite negligible or negative measured GDP growth, owing to a confluence of factors particular to the period. First, it is possible that output has grown somewhat more than measured GDP (see Chapter 2). Second, the informal sector and the undergroundeconomy have continued to provide employment, which may be one of the factors in the underestimate of GDP. Third, inflation, a "tax" that particularly hits the poor because of their use of currency, has fallen. Fourth, the relative price of food has fallen, reflecting the falling price of imported food because of both trade liberalization and the appreciation of the currency. In addition, rising real wages (arisingpartly from backward indexed wage contracts, and partly from strong union pressure) and remittances may have helped reduce poverty. However, the impact of rising real wages on poverty i s mitigated b y the likelihood that many formal sector employees already had incomes above the poverty line and because the rising real wages (along with the appreciating real exchange rate) contributed to a decline informal sector employment that particularly affected females. Remittances have grown sharply in dollar terms, but their effect on poverty seems to be one of maintaining incomes, rather than raising people out of poverty. 1.35 For the period 1989-2001, a strong statistical relationship exists between poverty and real GDP, inflation, and the relative price o f food." This relationship explains relatively well not only the sharp rise in poverty in 1991 but also the observed fall in poverty (see Figure 1.3). According to that relationship, the elasticity o f the head count with respect to GDP (percent change in the headcount divided by the percent change in GDP) i s 2.8, a relatively large figure b y international standards. This elasticity implies a ten-percent increase in real GDP would reduce the head count by the relatively larger figure of 28 percent, Le., from the 17 percent currently to 12 percent. A ten-percentage point fall in inflation would reduce the poverty head count by 3 percentage points, i.e., from 17 percent to 14 percent and a ten-percentage point reduction in the relative price of food would reduce the poverty head count by almost 4 percentage points, i.e. from 17 Poverty Head Count = 48.1 -0.0036** Real GDP + 0.30** Inflation 37.8" Re1Price of Food (base =1.0) lo The estimated equation is: + "t" statistic (-2.8) (6.4) (1.9) R2adj,=0.90 where ** signifiesa variable i s statistically significant at the 95 percent level or better,* atthe 90 percent level or better. Real GDP is measured in millions of J$ in 1986prices, inflation is measured in percentage points per year from December to December, and the Relative price of food i s measured with 1988 as the base year equal to 1.O. Estimates using the real exchange rate instead of the relative price of food were not quite as good in statistical terms, perhaps reflecting the fact that the relative price of food reflects changes in protection as well as the real exchange rate. Estimates using real GDP per capita were nearly as good in statistical terms, but yielded improbably high estimates of the relationship between GDP and poverty. 46 percent to 13 percent. O f course, these estimates reflect both any underestimate of GDP growth and the other factors that were occurring during the decade and their correlation with the 3 variables." Figure 1.3 50 _. Jamaica: Poverty Head Count Actual and Regression Prediction 40 - ,I +n .=0 c 30 - 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 -.e-Actual - -& RegressionPrediction - 1.36 Unfortunately, it i s unlikely that the macroeconomic factors that contributed to the recent poverty reduction and offset the impact of slow growth on GDP will continue to operate in the next few years. Indeed the slowing impact of these factors may explain why the incidence o f poverty has leveled off since 1999. Further gains from falling inflation and lower relative food prices are unlikely-inflation has leveled off and the real exchange rate has begun to depreciate. Only further reductions in protection of agriculture, such as cuts in stamp duties, are likely to limit rises in relative prices of food. Growth of the informal sector has helped maintain employment and contributed to unmeasured GDP growth, but it i s unlikely to grow rapidly without faster growth in measured GDP. Whatever the impact of rising real wages has been, it i s unlikely that employers will be able to continue to give wage increases in excess of inflation and productivity, given the openness o f the economy and associated competitive pressures. Pressures for wage increases not justified by higher productivity are likely to continue to reduce employment and to slow growth, especially since the need for fiscal stringency will reduce the public sector's demand for labor. Remittances may play a greater role in poverty reduction in the future, assuming remittances continue to grow in dollar terms and the real exchange rate depreciates. Finally, it should be noted that in all countries poverty becomes harder to reduce as the proportion of people in poverty decline. A closely related point, as suggested by international experience, i s that the elasticity of poverty with respect to GDP declines as the level of GDP rises. I`For example, the estimated impact of inflation included both the decline in the inflation tax and the extent to which real wage increases caused by "backward looking" labor contracts reduced poverty. 47 1.37 Future sustained reduction in poverty i s therefore likely to depend on sustained growth in the Jamaican economy as well as the implementation of policies to ensure that the poor are empowered to take advantages of the opportunities that arise from increased growth. A recent World Bank study, based on cross-country regressions, suggests that on average the income of the poor rises one-for-one with overall growth (Dollar and Kraay, 2001a). 1.38 It will also be important to ensure that Jamaica's growth is pro-poor-that growth raises the income of the poor at least as much as average income growth, if not more. The poor face a number of problems in benefiting from growth alone. This i s illustrated by the aforementioned World Bank study, which implied that in half the countries, income of the poor rose less rapidly than overall growth. As in most countries, Jamaica's poor are more likely to be members of larger households, be in female-headed households, have less education, and be employed in the rural sector-agriculture or fishing. In Jamaica, poverty also appears to be strongly correlated with social factors including: teenage pregnancy; single parenting; drug abuse; domestic violence; and child abuse and delinquency, though these associations are often the result of poverty, rather than its cause. As the cross country evidence demonstrates, policies that promote growth in demand for labor, and access to education, health and social services (as discussed in Chapters 2,5,7), can help to reduce poverty, reduce the vulnerability of the poor and allow the poor to take advantage of opportunities that are generated when the economy grows. Policies that address structural rigidities infactor markets will also be important to ensure that Jamaica's growth i s broad-based. 1.39 Rural poverty i s also an issue that should be addressed. The incidence of poverty in the rural areas, at 24.1 percent, is more than three times higher than that in Kingston. However, the low correlation between the fortunes of agriculture and the level of rural poverty suggests that rural poverty issues are much broader than agriculture alone and the non-farm productive sector may require attention. There i s therefore need for a comprehensive rural strategy that embraces the multidimensional nature of rural development, including addressing issues of governance, infrastructure and the cost of credit. 48 CHAPTER 2: UNDERSTANDING GROWTH INJAMAICA I. OVERVIEW 2.1 Jamaica's measured GDP growth was low in the 1990s while, paradoxically, measured investment was high.' Average growth actually was negative in the period 1996-2001 as output fell in agriculture and manufacturing. Jamaica's lack of growth i s often explained by the financial crisis (discussed in Chapter 4) and the poor external climate, which offset the gains from the liberalization of the early 1990s. In addition, the appreciation in the real exchange rate, which arose from the post crisis stabilization, and the rise in real wages hurt tradable goods production especially. Another factor in the loss of competitiveness has been the cost of crime. Even tourism, priced in U S dollars, has grown slowly and suffered a decline in market share, as the rising costs in dollars limited growth and cut into the earnings of investors and the government from tourism. Rising government consumption also burdened the economy. GDP growth may have been underestimated, however. Much of any underestimation of growth appears to be in services, which are always difficult to measure, and in the informal sector. Nonetheless, growth, even adjusting for a possible underestimation of 1-2 percentage points per year, was low. 2.2 At the same time, much of the investment of the early 1990s has produced little output, suggesting the capital stock i s overestimated and the high recent investment rate was concentrated in particular sectors that, while profitable, may suffer from distortions. Investments made in the early 1990s are often underutilized currently, because o f overbuilding, high costs measured in foreign currency, and difficulties of running multiple shifts in a high crime environment. Some capital was also destroyed in hurricanes. Investments in security of course yield no measured additional output and, indeed, crime may reduce the productivity o f the existing capital stock by reducing multiple shift operations. Recent investment was concentrated in hotels, mining, telecommunications, and housing, where in some cases measuring output i s not easy and in some cases distortions may have reduced investment's contribution to production in the national accounts, even though it yielded benefits to the investor. 2.3 Whatever growth occurred, it did not generate much employment - private sector employment has fallen, particularly in the formal private sector. This decline seems related to the loss of external competitiveness and the large increases in real wages, which fed back into a loss of competitiveness (discussed in Chapter 7). Slow growth in employment opportunities and the high crime have probably contributed to the This report does not explore issues relating to volatility of income and growth, which small, open economies like Jamaica's are susceptible to. Volatility arises from frequent natural disasters, openness to trade, and lack of economies of scale. Small size also limits the ability to establish institutions that would normally help manage exposure to shocks. For more details on volatility in the Caribbean countries at both the macro and household levels, see World Bank (2002~). massive migration of secondary and tertiary graduates, which in turn raises the issue of the large subsidy to higher education. 2.4 Generating higher growth will not be easy. The informal sector has only limited potential without growth in the rest of the economy and does not present many opportunities for productivity gains. Ultimately, growth will depend on a policy environment that increases external competitiveness as well as key infrastructure investments. 11. SLOW GROWTH, HIGH INVESTMENT, LOW EMPLOYMENT GENERATION 2.5 Although poverty has declined recently, Jamaica's recent GDP growth has been negligible, as it was over most of the last 20 years and was actually negative in 1996- 1999 (Table 2.1). The only exception to slow growth was the latter half of the 1980s. During the 1990s, Jamaica's per capita GDP growth was in the lowest quartile of countries (Loayza, et al, 2002 data base); its TFP growth was amongst the lowest in Latin America and the Caribbean (Annex Table 2.5). GDP growth turned positive in 2000 and was 1.7 percent in 2001 and 1 percent in 2002, but this barely offset the decline over the previous four years. Table 2.1: Jamaica GDP Growth, Employment Growth and Investment Rates: 1981-2001 - Average Average 1981-1985 1986-1990 1991-1995 1996.2000 1996 1997 1998 1999 2000 2001 1996-2001 Percentper year GDP growth 0.1 4.9 0.9 -0.7 -1.3 -2.0 -0.5 -0.4 0.7 1.7 -0.3 Employment growth 1.7 2.6 1.5 -0.6 -0.4 -1.4 0.7 -1.0 -1.1 0.6 -0.4 Percentof GDP (nominal) Gross Cap Formation% GDP 20.4 22.7 27.8 27.8 29.7 29.8 26.7 25.1 27.6 30.1 28.2 Construction Yo GDP 10.0 10.8 13.1 12.2 12.6 12.2 12.0 12.4 12.0 12.2 12.2 Machinery & Equip. % GDP 7.3 7.8 9.9 10.9 12.8 10.8 10.2 9.1 11.7 13.4 11.3 Transport % GDP 3.1 3.4 4.3 4.5 4.2 6.6 4.3 3.5 3.7 4.3 4.4 Public Investment 8.0 6.9 5.0 3.9 5.6 5.1 2.7 3.1 2.9 . PrivateFixedCap Formation 12.4 15.8 22.8 23.9 24.1 24.7 24.0 22.0 24.7 - Memo: EstimatedGDP EstXontrib. Capital Emp. Growth of Total Factor Sourcesof Growth 1991-2000 Growth to Growth: Growth Growth Productivity (Residual) Loayzaet al. (WBsourcesand estimates) 0.3 1.9 1.4 -3.0 Baiteisman (STATINSourcesand estimates) 0.7 1.2 0.3 -0.8 Sources: National IncomeProduct2001, STATIN; Economicand Social Survey, PIOJ, various issues; WDliGDF Central database,World Bank. 2.6 Some general explanations for slow growth in the 1990s are well known-the financial crisis that followed the excesses of the late 1980s and early 1990s and the consequent monetary tightening, which left a massive, costly debt overhang (Chapters 3 and 4). In addition, the external climate deteriorated. These macroeconomic developments seem to have more than offset the potential effects o f the substantial trade and capital account liberalization of the early 1990s (Chapter 7). 50 2.7 A recent cross-country study quantifies these explanations and can account for most of the slow growth.2 The study finds that the decline in the growth of GDP per capita from 1980-89 to 1990-1999 (-1.9 percent per year according to World Bank data) can be almost completely accounted for by the negative impact of the financial crisis and higher inflation ("stabilization issues" accounting for -1.3 percent per year). These problems almost completely offset the positive impact of structural reforms (1.45 percent per year) that opened up the economy and reduced government consumption. This left growth to be determined by the negative influence of external factors (-0.7 percent per year) that affected all countries, and the cyclical reversion and convergence of the Jamaican economy back from the unusually high growth in latter half of the 1980s (-1.2 percent per year). (See Annex Table 2.6 and Loayza, et al, 2002, Table 11.4). 2.8 The study's comparison of changes within the 1990s sharpens these conclusions somewhat. In the latter half of the 1990s, the empirical results suggest even greater negative impacts from the financial crisis (reflecting more years of financial crisis), the burden from rising government consumption, and the increasing overvaluation. Meanwhile the positive impact of the structural reforms wears off. External conditions continue to have a similar negative effect on growth. And there i s no cyclical rebound, since growth inthe early 1990s was similar to the long runtrend (see Annex Table 2.6). 2.9 The question of course, i s what does this study imply for the future-when will stabilization efforts be able to stop, given the high debt level, when will international conditions improve, and what new structural reforms are needed, since those of the early 1990s have already begunto wear off. 2.10 Turning to sector level data, both agriculture and manufacturing output actually declined in the late 1990s. Poor weather and increased competitive imports at the appreciated real exchange rate hurt agriculture (though, as discussed in Chapter 1, lower priced agricultural imports helped reduce poverty). Textile production has declined by nearly 75 percent since its 1995 peak, as textile exporters left for Mexico, Haiti and the Dominican Republic. The reasons usually given for their departure are not only better access to U S markets in some of the other countries but also lower wage costs, lower infrastructure and security costs and less shipping problems (Chapter 7). Tire production has also shifted, to Trinidad & Tobago. 2.11 Only the transport & communications, power, and tourist sectors have grown rapidly since 1996. The tourist sector i s heavily dependent on Jamaica's natural resources-location and natural beauty. It is perhaps less dependent on cost competitiveness and productivity than other sectors. Nonetheless, an appreciated real Loayza, et al, 2002. The study's approach is a cross-country estimate of possible factors that are associated with growth, of the type used by Lucas, 1988 and Barro, 1991. In this approach, the "average" impact (coefficient) of various possible supply and demand factors on growth are estimated using cross- country data. Of course, the average impact of these factors includes the impact of the "average" policy response to them by the sample countries. For example, a financial crisis typically would be accompanied by certain monetary and fiscal policies, to a greater or lesser degree, which in turn would affect growth. These estimated "average impact coefficients can then be multiplied by the values of the variables in a particular country to see how well its growth can be "explained". 51 exchange rate means that prices in foreign exchange have to be higher to cover local costs, thereby reducing tourist arrivals and the country's earnings on its sites and its taxes. Financial services have grown since 1997 but are only back to the 1995 level. Moreover, though on a sounder regulatory base, the sector's assets are now largely government debt (Chapter 4). The real imputed bank service charge, a deduction from the sum of sector GDP, has grown nearly 40 percent since 1995, and its calculation may need some reconsideration-if it grew only as fast as sectoral GDP, then real GDP growth would be nearly one percentage point per year higher.3 2.12 Despite the slow GDP growth and highreal interest ratesflarge debt overhang, the estimated rate of gross fixed capital formation i s and has been fairly high. Gross fixed capital formation averaged nearly 28 percent of (nominal) GDP over the last decade and rose to nearly 30 percent in 2001 (Table 2.1). Jamaica's average investment rate was in the top quartile of countries in the 1990s, and well above the average investment rate of about 21 percent across countries (Loayza, et al, 2002, database). Though the investment rate did decline toward the end of the 1990s, after the financial crisis, the average investment rate from 1996-2000 was nonetheless higher than in the 1980s. Moreover, new foreign direct investment, which i s equal to about 12 percent of investment (excluding privatizations and retained earnings), has remained strong, which i s usually a good indicator of favorable market condition^.^ 2.13 Within investment, machinery and equipment investment has held up surprisingly well after the crisis and i s concentrated in telecommunications, tourism, and bauxite mining. Machinery and equipment investment represented a higher fraction of GDP recently than the average in either 1990-1995, or the 1980s. This i s in spite of the real appreciation of the exchange rate. In US dollar terms, imports of machinery and equipmentwere about 80% higher in 1999-2001 than in 1991-1993. 2.14 Construction also has held up well, but there appears to be a shift to housing and the informal sector. Real value added in construction, which i s associated with formal construction activity, has fallen much faster than GDP, almost 13% in 1999-2001 compared to 1993-1995. Government investment has declined over the 1990s as a percentage of GDP, being crowded out in the budget by rising debt servicing and wage costs (see chapter 3). Housing starts, though down since the mid-l990s, have held up surprisingly well because of public sector activity. On balance, these figures suggest a slight fall in the ratio of real construction to real GDP in the latter half of the 1990s, as compared to the constant ratio of nominal construction to nominal GDP that i s reported in the investment figures. For the 2002 GDP estimates, revisions were made to remove a portion of the imputed service charge associated with household consumption from the product side o f the estimates and include it in consumption estimates. Improvements have also been made in the deflation technique. Relating foreign direct investment to investment in the national accounts is difficult. In addition to the issue of foreign purchases of public sector enterprises (not a new investment), there are problems relating retained earnings to investment. Moreover, foreign owners of firms may borrow locally to make investments. 52 2.15 Employment has grown slowly and actually declined in the latter half of the 1990s (Table 2.1). This decline reflects both discouraged workers and the rise in open unemployment as employment in the formal sector grew slowly. Moreover, labor has shifted into the government sector, while private sector employment declined except for own-account workers. Moreover, migration, notably of those with tertiary education, i s large. Labor force issues are discussed more fully in Section VIbelow. 111. THE SUPPLY SIDE OF GROWTH 2.16 Jamaica's slow reported GDP growth and high investment rates imply low, if not negative, aggregate productivity growth. Although questions can be raised about the measurement of outputs and inputs, discussed in the next sections, the calculation also raises important issues for the future. 2.17 The negative aggregate productivity growth shows up formally in the traditional, Solow (1957) approach of analyzing the sources o f GDP growth in terms of the contributions of the growth of capital and labor and "total factor productivity", which i s really a re~idual.~Application of the standard Solow growth model to Jamaica suggests that (total) factor productivity declined 2.5 percent per year in the 1990s (Table 2.2, column 1). The decline in aggregate productivity i s even worse if adjustment i s made for the estimated increases in human capital, which tend to raise the growth rate of (effective) labor (Table 2.2, column 2). On the other hand, the decline in total factor productivity i s much less, when adjustment is made for informal sector employment and capital growth i s disaggregated and depreciated more rapidly (Table 2.2, column 3). 2.18 Negative productivity growth could come from diminishing returns or from the costs of crime. In the bauxite industry, there may indeed have been a decrease in productivity - more inputs are needed to make up for the decreasing physical productivity of the mines, although the profitability of the investment may still be high.6 However, in most industries, technology seems to have remained at least constant, if not Solow, 1957. In Solow's model, GDP growth is definitionally equal to the growth in capital and labor multiplied by their output elasticities and an unexplained residual that is called total factor productivity growth. Formally: Growth of GDP = a Growth of Capital + (1-a) Growth of Labor + Residual where a=% change in GDP/ % change in Capital, 1-a=%change in GDP/ % change in Labor. These elasticities may be estimated or, more commonly, are simply assumed to be the shares of capital and labor. In addition, it is usually assumed that the output elasticities of capital and labor sum to one (by definition the shares do); if there are economies or diseconomies of scale then their total would exceed or fall short of one, and the empirical application of the equation would tend to generate positive or negative residuals. Questions have been raised about the application of the formula because of theoretical problems in computing an aggregate stock of capital, and empirical problems of: (i) estimating the output elasticities (often simply taken as the income shares of labor and capital, which not only raises questions about the implicit assumption of competitive factor markets but also the empirical problem of splitting the earnings of the self-employed into returns to capital and labor), and (ii) estimating the base year capital stock and the rate of depreciation to be used under the permanent inventory method of computing the annual stock of capital as last year's capital stock less an assumedrate of depreciation, plus investment. Bartlesman, 2002, using heroic assumptions about the allocation of the total capital stock, estimates that aggregate productivity has fallen in the mining industry somewhat faster than in the rest of the economy. 53 Table 2.2 Jamaica Estimates of Sources of Growth 1991-2000 Loayza et al Bartlesman 1 2 Growth (averaae YOper year) of output 0.3 0.3 0.7 Capital 4.7 4.7 3.2 Labor 1.6 Labor adj for Human Capital 2.3 Labor adj. for Informal Employment 0.5 Total Factor Productivity -2.5 -3.0 -0.8 Memo LaborOutput Elasticity(shareof labor) 0.60 0.63 LoayzaSources: Output and Capital:World Bank (2002b),capital based on updatingof Nehruand Dhareshwar(1993) Labor : ILO and ECLAC BartlesmanSources: Output, Capital,and Labor: STATIN; Labor adjusted by reducingnon-formallabor by 60 percent. improved. It i s possible that increasing investment in security and crime prevention, which does not add directly to output (see discussion below and in Chapter 6), could generate a decline in aggregate productivity g r ~ w t h . Whether these investments are ~ large enough to lead to a decline in estimated productivity growth in the aggregate i s not clear. 2.19 The estimate of falling productivity, as well as the high rates of presumably profitable new investment, raise the issues of measurements of GDP, capital and labor, as discussed below. These issues of measurement are not sterile discussions; they raise important issues about the kind of economy Jamaica i s turning into and the problems of raising growth. IV. JAMAICA'S GDPGROWTH M A Y BEUNDERESTIMATED 2.20 A number of factors suggest that Jamaica's GDP growth is underestimated.* Underestimation of GDP growth would reduce the apparent paradox of high investment Note even if productivity in the mines fell, investment would still be profitable, if world prices of bauxite are expected to rise faster than the productivity o f the mines declines, power costs fall, or the industry receives tax concessions. 'Note that the issue is not whether productivity is low, but whether productivity growth is negative-in other words, declining productivity. Underutilization of facilities such as tourist hotels for much of the year will contribute to low productivity, but to declining productivity only if the degree of underutilization i s increasing over time, on which there is no evidence. In the case of investments in security, they would add to the capital stock and be multiplied by the average elasticity of output to generate a contribution to output, but no increase in measured output in GDP, in other words negative factor productivity. Again, the issue i s not whether GDP i s underestimated, but whether the degree of underestimation has increased over time. With regard to the growth models discussed above, an underestimation of GDP growth would mean that total factor productivity growth (the residual in the Solow approach) would be 54 (and increasing foreign direct investment) despite low measured GDP growth. It would also reduce the paradox of low growth and rapid poverty reduction. 2.21 One indicator that GDP growth may be underestimated i s the large difference between consumption growth in the GDP accounts and the annual household Survey of Living Conditions.' Between 1995 and 2001, estimates of real per capita consumption from the household survey grow by 3.8 percent per year, while real per capita consumption in the GDP accounts declines by 1.5 percent per year (see also Chapter 1). Corroborating evidence for an underestimation i s the decline in poverty in the latter half of the 1990s according to the household survey (Chapter 1). The difference between the estimates of consumption in the survey and GDP naturally raises the question of which i s a better estimate." Some independent real indicators of consumption, such as apparent consumption of meat and fish, purchases of electricity, and cars and trucks licensed, all seem to be growing much faster that would be the case if GDP per capita had fallen (see Box 2.1)." 2.22 On the production side of the national accounts, the basis for the GDP estimates, STATIN generally does an excellent job of applying standard methods on the formal sector. Specifically, STATIN estimates of real GDP are largely based on the standard methodology of applying value added coefficients to indicators of output growth or deflating value added by output prices. In other words, input and output prices are generally assumed to move together, although improvements are continually being made in deflation techniques. Thus, in the formal sector, one potential explanation for the possible underestimation of Jamaican growth may be the differential movement of output and input prices, perhaps leading to misestimates of real value added, which i s the more positive and Jamaica's growth would show a larger unexplained residual in the cross-country approach. Jamaica's GDP estimates are largely based on estimates of value added by industry. On the demand side, nominal values of government spending, estimated investment, and net exports of goods and services are obtained directly. Consumption is estimated using a commodity flow method, then adjustments are made to equilibrate the demand and production side of the accounts. If the resulting estimate of consumption were increasingly underestimated, then GDP (value added in production) probably would be increasingly underestimated. Note that remittances, which are important in Jamaica, are not, by themselves, an explanation of why consumption, and thus production, may be underestimated. The reason i s that when the additional purchasing power provided by remittances i s translated into consumption, the goods that are consumed must either be produced or imported. Hence, the issue is not remittances per se, but the extent to which the estimates of production and net imports match up with independent estimates o f demand, including an independent estimate of consumption that includes consumption financed by remittances. lo The ratio of consumption in the survey to consumption in the GDP accounts varies substantially from year to year, with 1995 consumption in the survey the smallest fraction of consumption in the national accounts. (Nominal) consumption in the survey grows much faster than (nominal) consumption in the national accounts after 1995, as shown in Table 2.2 in the 2000 SLC. One explanation may be a change in the survey methodology, but the 1997 SLC specifically denies any change in the methodology, as noted in Chapter 1. O f course, one explanation of the difference in the growth rates between the survey and the national accounts is that the national accounts are increasingly underestimating GDP; another is that the national accounts underestimated the severity of the recession in the crisis. Unmeasured output, plus the rapid growth of remittances, are both potential sources of income that can be spent on consumption, part of it produced in the poorly recorded sectors. l1 Also, Jamaica's current consumption of infrastructure services like electricity, air transport, telecommunications, seem to suggest that the level of GDP may be underestimated (Ehrhardt et a12003). 55 difference between real outputs and real inputs. However, a recent study carried out for this report suggests that taking into account differences between real output growth and real input growth makes little difference in estimates of real GDP growth (Havinga, 2002). STATIN plans to shift to separate deflation of both outputs and inputs (double deflation) in the future, depending on the availability of data. Box 2.1: ConsumptionIndicators Purchases of a number of commodities seems to have grown fairly fast in the 199Os, despite falling measured GDP per capita. These figures suggest consumption and thus GDP growth is underestimated. These figures are estimated separately from both the GDP accounts and the SLC, and thus provide something of an independent check of the other two estimates. These are all luxury goods, with income elasticities of demand typically above 1. Hence consumption probably should have fallen if GDP per capita declined. To some extent purchases may have risen because of relative price effects, but these goods all have a domestic component. Also, as income distribution appears to have changed little (Chapter 2), it is unlikely that shifts in income distribution could explain these growth rates of consumption. Jamaica: Real Indicators of Consumption: Averacle Annual Growth Rates 1990-1995 1995-2001 Meat & Fish Apparent Cons.*(tons) 0.7 6.4 Power Sales (kwh) 3.9 6.5 HouseholdConsumersof Power (number) 4.5 4.3 Cars &Trucks Passingthe FitnessTest (number) 8.3 8.5 Source: STATIN, Economicand Social Sunleys * ADDarent ConsumDtion= Productiont ImDorts- EXDO& 2.23 Service output i s inherently more difficult to estimate than goods output, particularly in an open economy like Jamaica. Services represent about 70 percent of the economy. The main growth sectors have been telecommunications (10.5 percent p.a. average growth in the period 1995-2001), transport (4.5 percent per annum), and hotels (2.5 percent per annum growth). Nonetheless, their growth may be underestimated, particularly since part of the income in telecommunications and hotels (tourism) i s reported overseas.' The growth in tourism seems surprisingly low. There i s also the knotty theoretical issue of the treatment of increases in real wages or spending on services, in sectors where the growth in value added i s estimated by growth in employees (government) or numbers of visitors (tourism). 2.24 Another potential explanation of the possible underestimate o f GDP growth may be an underestimate of illegal and informal activities, which are difficult to measure inall countries. As the media widely reports, the drug trade i s an important activity inJamaica. However, according to the UN, the level of Caribbean drug exports has not changed much since the early 1990s, and Jamaica has lost its share in marijuana sales (UNODC, 2003). Of course, the drug trade by its nature is difficult to estimate. However, if the UN estimate i s correct, then the drug trade may account for an underestimate in the level of '*The charges on fixed line, international calls are split between the two countries; the division on international cell phone calls i s defined in contracts, and the imputation of both items for purposes of national accounts may needa reassessment. Tourist packages are typically paid offshore. 56 GDP of, perhaps, 15 percent, but not much of an underestimate o f growth. In contrast, informal and underground production may have increased as a result of the imposition of the General Consumption Tax in 1991. Red tape and bureaucracy in setting up businesses, which often generate complaints, may also have led to the growth of unrecorded production, although there i s no direct evidence that bureaucratic bottlenecks have increased over the 1990s. Finally, as i s well known, not only has the share of GDP in services risen but, since 1995, so has the share of the own account workers and micro and small establishments in the private labor force, where output i s difficult to measure (see Section IV). On the other hand, the number of own account workers has not increased since the mid-1 9 9 0 ~according to the employment survey. Hence, whatever ~ growth has taken place in the sector would appear to reflect higher per capita incomes. 2.25 STATIN has made attempts to include estimates of the informal sector in the GDP accounts, using different approaches in different sectors. In agriculture, the drug trade i s not included, but attempts are made to estimate small farmers' production. In manufacturing, STATIN notes that it beginsits estimate of output with data on firms with more than 10 employees but then adds in estimates o f the output of smaller firms based on data from income taxes, commodity flows, and the surveys of household expenditures, living conditions, and the labor force. More important issues may exist in the construction and services sector. Services have grown relative to goods production and are inherently more difficult to estimate than goods output. For example, estimates of distributive trade are based on commodity flows and historic margins, which may need review. Again, the issue i s whether this activity has increased relative to GDP over time. Real estate and business services also are always hard to estimate. In Jamaica, the level of estimated imputed rents of owner occupied housing seems low compared to other economies (Havinga, 2002), particularly given the apparent shift to housing construction suggested by the decline in value added in formal construction in the national accounts. However, the growth o f imputed rents over time, slightly higher than GDP growth, may only be slightly underestimated. Finally, there i s the complicated issue of estimating and attributing the imputed margins of the banking sector, which in Jamaica i s estimated directly (FISIM) and then subtracted from the total of sectoral outputs to calculate GDP, rather than imputed on a sector-by-sector basis. As noted, it may be desirable to revisit the estimation of this variable, given that the estimated value rises sharply in real terms over the decade (despite the problems in the banking sector) and correspondingly lowers the real GDP growth by about one percentage point per year.13 2.26 One often-used indicator of the underground economy i s the ratio of currency to GDP (Feige, 1990), a ratio that has increased by about 74 percent in Jamaica since the early 1990s and 28 percent relative to the late 1980s (see Table 2.3).14 Moreover, this increase has occurred despite the legalization of US$ deposits and currency holdings in 1991, with the establishment of capital account convertibility. Given the expected rates of return, there should have been a substitution of U S currency for Jamaican currency, l3See Havinga, 2002, and various STATIN publications for details on sectoral estimates of output. l4While part of the increase over the early 1990s might reflect the concern over weakness of financial institutions, that concern should largely be gone by the end of the 1990s,after the government effectively guaranteedfinancial sector liabilities and then established a formal deposit insurance fund in 1998. 57 which in turn suggests that total currency usage has grown even faster than the growth of Jamaican currency would suggest. Ignoring the growth of holdings of US$, if we assume, conservatively, that say two-thirds of the rise of Jamaican currency usage over the 1990s reflects a response to continued concerns about the banks, falling inflation and other factors, then the remaining one-third would be associated with the relative growth of unmeasured activities. This would imply that nominal, and real GDP in 2000 was underestimated, relative to 1990, by between nine to twenty-five percent (depending on whether the comparison of currency holdings i s with the late 1980s or early 199Os).l5 This in turn would imply that real GDP growth from 1990 to 2000 averaged almost 1-3 percent per year, presumably concentrated inthe post-crisis years. Table 2.3 Jamaica: The Risein Currency Holdings, 1991to 2001 Average Average Average Ratio Ratio 1987-89 1991-93 1999-2001 '99-'01/ `99-'01 / 1987-89 `91-`93 Currency (June)/GDP (percent) 3.7 2.7 4.8 1.28 1.74 Source: Bank of Jamaica. 2.27 To summarize, there are some indications that Jamaica's GDP and GDP growth are underestimated. The rapid growth of consumption in the SLC and of some physical products and electricity usage i s one such indicator, another i s the rise in the use of currency. There are the standard difficulties of estimating informal activities and service output, compounded by the open nature of Jamaica's economy. There i s also the issue of the large rise in the estimate of the real imputed banking services. Adjusting for an underestimate might raise GDP growth by perhaps 1-2 percentage points per year. This i s a better growth rate, but not an outstanding growth performance. Moreover, much o f The argument is as follows: the ratio of currency to measured nominal GDP in 1999-2001 i s 28 (74) percent higher than if 1987-88 (1991-93) ratio prevailed. If all of the difference were due to a relative increase in the informal sectorhnderestimate of GDP, this would imply nominal GDP was underestimated by 28 (74) percent in 1999-2001, compared to the earlier years. Assuming prices rose the same in the informal and formal sectors, this would further imply all of the difference was due to an increasing underestimate of real GDP. Of course, some of the increase in currency use may be attributed to the public's concerns about the banks and some may be attributed to the fall in expected inflation. Inaddition, the informal sector probably uses more currency than the formal sector (Feige, 1990),so its relatively faster growth would create an additional rise in the ratio of currency to nominal GDP. Suppose simply that only about one third of the rise in the currency ratio i s due to the relative growth of the informal sector, two thirds due to concerns about the banks, the fall in inflation, and the higher use of money by the faster growing informal sector. (The alternative is to estimate this split by imposing a more sophisticated model and assumptions about the relative size of the informal sector in the base year and assumption or estimates of the income and inflation elasticities of currency demand in the two sectors, see Bennett, 1995 for an example applied to Jamaica in the 1980s). This would imply that the underestimate of real GDP had increased by between 9 and 25 percent since the early 199Os, and growth was underestimated between 0.9 and 2.9 percent per year compared to a constant rate of underestimation of the informal sector. Presumably, GDP was also underestimated in 1990 and some of the money stock was used for these activities. But this calculation shows how much the non-included activities rose faster than a constant rate of underestimation, based on the rise in the use of currency. 58 this growth may have come in informal activities, where future productivity growth is likely to be small. The next two sections discuss the measurement of capital inputs and the growth of employment and its implications for future job growth. V. CAPITAL INPUTS 2.28 Jamaica's high investment rates may reflect rapid growth of real wages and the appreciation of the exchange rate, but the effective growth of capital also may be overestimated, thus suggesting an underestimate of the increase in total factor productivity. Rapid growth of real wages encourages substitution of capital for labor, and a more capital intensiveAess labor intensive growth path. Similarly, an appreciating real exchange rate reduces the relative price of imported machinery and equipment, which represents almost all of Jamaica's investment in machinery and equipment, and thereby encourage investment. Thus, the pattern of price movements in the labor market and the exchange market may have contributed to a rising capital intensity in Jamaica. However, increasing capital intensity does not explain the negative growth in total factor productivity; the explanation probably lies in overestimates of the growth of capital stock and its productivity. 2.29 One possible source of overestimating capital growth i s the use of too low a base year capital stock and too low a depreciation rate, which translate into an overly rapid growth of capital.16 The comparison of the two recent estimates of capital stock growth above gives some idea of the issue. The Loayza, et a1 (2002) capital stock estimates, taken from earlier World Bank estimates of capital stock in all countries using common assumptions on depreciation, are substantially greater the Bartelsman (2002) estimates which are based on a more detailed breakdown o f investment, and depreciation rates and initial capital stock, all specific to Jamai~a.'~As a result, Bartlesman's figures imply a smaller growth in capital, a correspondingly smaller difference between the weighted sum of inputs and the growth of output and, thus, a less negative figure for total factor productivity growth. 2.30 Hurricanes are a particular issue for measuring capital stock in Jamaica, as they reduce the capital stock and imply much of the investment i s simply for replacement. In Jamaica, and other Caribbean economies, the weather probably makes the depreciation rate of capital stock not only higher, but also more variable than can be accounted for by a low, steady, depreciation rate. Bartlesman's capital stock estimates include a relatively highaverage depreciation rate to account for hurricanes. l6I n the standard, permanent inventory method of computing the growth of capital, there is always an issue of estimating a base year capital stock (ifone does not exist) and a depreciation rate to calculate the growth rate of capital-if a low base year capital stock or a low depreciation rate are used, then the growth of capital will be too high (capital deepening), the contribution of capital to growth will be overestimated and the growth of total factor productivity will be underestimated. l7Bartelsman (2002), divides investment into six types, applies specific depreciation rates for each based on U S GDP methodology (which takes into account obsolescence), adjusts depreciation upward to allow for hurricanes, and then cumulates the estimates from 1960 onward to get a capital series for Jamaica, which implies a thirty percent lower estimate of capital than in Loayza, et a1(2002). 59 2.31 A second, standard problem in estimating capital stock is capacity utilization, a potentially important problem in Jamaica after the financial crisis. As the number of manufacturing and financial firms have declined, real non-housing rentals have declined by about 20 percent since 1995, according to the nationalaccounts. Some of the buildings constructed in the building boom of the late 1980s and early 1990s are still partially empty. Inaddition, the aforementioned departure of textile producers has left empty the buildings in the export zone, which are only gradually being converted to other uses. More generally, capacity utilization of machinery as well as structures may have declined due to the recession inaggregate demand. Adjusting the capital stock for such changes in capital utilization would imply a much slower growth of capital and a higher growth of total factor productivity than the figures shown inTable 2.2. 2.32 Another issue i s the concentration of new investment in sectors such as housing and hotels where its productivity, in terms of GDP, may be reduced by distortions. For example, housing i s desirable for the welfare of the PO ulation, but adds to future GDP only by the imputed value of owner occupied housing.PS The economic productivity of housing may be less than directly productive investment because of the lower taxes on owner occupied housing services that encourage housing investment, relative to plant and equipment, and by direct subsidization of housing access. Inhotels, differential taxes and tax incentives may generate "over investment" because of individual profit rates that differ significantly from the investment's contribution to output (Artana and Navajas, 2002). To generate an aggregate capital stock including housing and other activities, the value of investment must be weighted by their relative productivity, not relative prices. Thus, to the extent that the share of housinghas increased ininvestment, the capital stock has grown less rapidly than the sum of investment weighted by relative prices. 2.33 Low productivity of investment in security against crime i s particularly pertinent to Jamaica (See Chapter 6). While such investment can reduce the impact of crime on the business that invests in it, from the standpoint of the economy its future productivity i s negligible. Moreover, the threat of crime also tends to reduce the productivity of all investment, by makingmultiple shift work unattractive to the workers. Hence, increasing crime could leadto a reduction in total factor productivity. 2.34 In sum, the growth in capital stock may indeed be overestimated by Jamaica's highinvestment rate. A key issue for future growth is to increase the productivity of the investment. Reduction in crime, as discussed in Chapter 6, will help to reduce the need for relatively unproductive investment and increase utilization rates. Increases of domestically oriented investment and housing are unlikely to be very productive, especially once the large investment boom in telecommunications i s completed. Hence, increased productivity of investment i s likely to depend on encouraging greater competitiveness intraded goods. l8 As noted above, the GDPattribution for owner-occupied housing inJamaica seems low by international standards. 60 VI. THE LABORFORCEAND GROWTH 2.35 The slow growth of employment in Jamaica over the 1990s suggests that GDP growth, whatever the degree of underestimation, has been too slow to generate rapid growth in employment demand. As can be gleaned from Table 2.4, employment has grown at an average rate of less than 0.3% per year from 1991-2001. Even before the crisis fully hit, over the period 1991-1996, employment grew less than 6 percent, while the rate of unemployment rose. From 1996 to 2001, when Jamaica was undergoing a crisis and then recovering, employment actually fell b y over 2 percent. While employment did rise somewhat in 2001 and 2002 (1.3 percent and 1.6 percent respectively), at roughly the same rate as average GDP growth over the two years, it remains to be seen if this increase i s transitory. The entire increase of about 21000 people between 2000 and 2002 owes to the increase in public employment and there are also issues of statistical comparability of the data.lg 2.36 Other aspects of the labor force confirm the slow growth of employment opportunities (Table 2.4 and Annex Table 2.7). The labor force actually declines between 1996 and 2001, suggesting a withdrawal of workers from job seeking. Within employment, employment in the goods producing sector has fallen at an increasing rate over the 1990s (Table 2.4), much faster than goods output. Female employment has fallen, largely reflecting the loss of jobs in the textile industry. Public sector has increased by about 11,000 jobs, perhaps indicating an implicit contra-cyclical policy of employment. However, private employment has fallen even faster than total employment, with a loss of some 50,000 jobs since 1996. Only own-account employment has been stable, and hence has become an increasing share of the employed since 1996. 2.37 Surprisingly, average wage and salary earnings (in large establishments) have risen strongly despite the fall in employment - a fact that suggests that this part of the labor market does not seem to be working very well and that employers may even have reduced their hirings and increasingly substituted capital for labor because of high wage demands supported by strong unions. Between 1995 and 2000, average real weekly earnings in J$ have more than doubled (a compound growth rate of 16 percent per year- PIOJ, ESSJ various issues), and, in US$, earnings have almost doubled. These wage increases are probably a factor in the falling labor intensity of output, decline in labor demand and the loss of competitiveness in goods production. As shown in Chapter 7, growth of wages in excess of productivity has been a major factor in the loss of exports, particularly apparel exports. l9Until 2000, the labor force and employment numbers were based on an average of four surveys in each year. In2001 and 2002, only two surveys were done, January and April in 2001, and April and October in 2002. These changes raise the issue of comparability of the data with those of previous surveys, owing to possible seasonal effects, as discussed in PIOJ, 2002 ESSJ, page 21.3. In addition, the 2002 survey incorporated a new sample frame to increase the falling response rate of interviewees, as well as a new sample design, thus affecting comparability with earlier surveys. In 2001, employment rose by 1.3 percent compared to the same January-April period in 2002. In 2002, employment rose 1.6 percent, but this could be seasonal. More importantly, it was the large increase in public employment (mainly short-term contract workers relating to flood damage, other capital projects, and for the Electoral Office and the Population Census) that was almost entirely responsible for the increase in overall employment. 61 Table 2.4 Jamaica: Labor Force Indicators, 1991-2000 (Annual Averages, 000workers) 1991 1996 2000 2001 2002 Labor Force 1073 1143 1105 1105 1125 Employed 908 960 934 939 954 O.W. Agric. Mining, & Manufacturing 348 324 270 268 261 Construction & Services 560 636 664 672 694 O.W. Female Employment 390 407 381 385 402 Male Employment 518 553 552 555 553 O.W. Own Account 338 332 337 322 O.W. Private Sector 812 868 828 837 834.5 O.W. Public Administration 96 92 106 103 120 Unemployed 165 183 - - 172 165 170 Source: Economic and Social Survey, PIOJ, Government of Jamaica, various issues. 2.38 Surprisingly, average wage and salary earnings (in large establishments) have risen strongly despite the fall in employment - a fact that suggests that this part of the labor market does not seem to be working very well and that employers may even have reduced their hirings and increasingly substituted capital for labor because of high wage demands supported by strong unions. Between 1995 and 2000, average real weekly earnings in J$ have more than doubled (a compound growth rate of 16 percent per year- PIOJ, ESSJ various issues), and, in US$, earnings have almost doubled. These wage increases are probably a factor in the falling labor intensity of output, decline in labor demand and the loss of competitiveness in goods production. As shown in Chapter 7, growth of wages in excess of productivity has been a major factor in the loss of exports, particularly apparel exports. 2.39 The slow growth of employment opportunities has added to the pushof crime and the pull of high foreign wages in encouraging emigration from Jamaica. Despite restrictive immigration policies, estimated emigration rates to the US and Canada have averaged over 20,000 per year in the 1990s (PIOJ, ESSJ various issues, based on U S and Canadian data, data include students), though emigration has slowed recently, perhaps reflecting tightening immigration restrictions in these countries. Even though general migration to Canada and the UK has slowed, migration to the US under family reunion provisions continues. Emigration at this rate means that migration absorbed much of the potential growth in Jamaica's labor force during the 1990s. In addition to permanent emigration, a policy of temporary migration to the US for hotel and farm work accounts for over 10,000 temporary emigrants per year. 2.40 The outflow of educated people i s especially large and has been less affected by the tightening of immigration restrictions. Bratsberg and Terrell (2002), using 1980 and 1990 US census data, find that the weighted average migration rates of male Jamaican workers top all 67 countries in both years in the United States. B y contrast, in Singapore, which has about 3 million people, migration rates of those with primary and secondary education in 1980 and 1990 were below 1 percent, and the rates of those with tertiary education was 2.5 percent in 1980 and 4.8 percent in 1990. (Bratsberg and Terrell, 2002, Table A2, p. 195-196). An estimate based on the 1990 U S census suggests that some 62 90,000 Jamaicans with secondary education and 66,600 with tertiary education were living in the US in 1990.20 These figures overestimate the "brain drain", since some of these Jamaicans probably received part of their education in the U.S.21 Nonetheless, these figures suggest that in 1990, between 25 and 30 percent of Jamaica's secondary graduates and over 2/3 of its tertiary graduates were in the U.S. (Carrington and Detragiache, 1998, Table 2). 2.41 More recently, Jamaican nurses have now become an important part of health services inthe US. There have been systematic recruitment efforts from the UK andNew York City for Jamaican teachers. A rough estimate o f the total migration, made by comparing to the numbers of resident tertiary graduates shown in the household surveys to the number of graduates over the 1990s, suggests that the equivalent of about 80 percent of tertiary graduates inthe 1990s had emigrated.22 2.42 The large emigration of educated Jamaicans raises the issue o f the high cost of educating university students who then migrate. For many Jamaican students, the cost of secondary and tertiary education i s largely paid by the state-fees, though a burden on middle class households, cover only about a fifth of secondary and tertiary education's costs. Thus the Jamaican taxpayer i s not only subsidizing the education of people from higher than average income families and who will have higher than average incomes once they graduate, but who will not even pay taxes on those incomes, nor provide any benefits to the community in terms of teachinghursing. It i s true that the emigrants send remittances (though some of these "remittances" may be drug related payments). However, the remittances are only a small fraction of the income they earn and they are taxed only when spent. Moreover, the remittances tend to appreciate the real exchange rate, making exports of goods and services less profitable and thus dampen the demand for labor inJamaica. VII. RAISING GROWTH INJAMAICA 2.43 Growth has been negligible in Jamaica in the latter half of the 1990s, despite high investment rates. The foregoing discussion suggests that GDP growth in Jamaica i s probably underestimated, because of the growth of informal, underground and illegal activities. However, the upward adjustment of growth could be 1-2percentage points per year, enough to turn the growth of aggregate productivity positive (at least according to some estimates), but still not an impressive performance. Much of the growth in (recorded and unrecorded) GDP i s in the informal sector where productivity growth i s likely to be low in the future. Meanwhile investors in such sectors as textiles and tires have left Jamaica. Jamaica seems to have lost competitiveness in goods production because of world conditions, but also because of the appreciating real exchange rate and 2o Carrington and Detragiache, 1998. Migrants are defined as foreign-born residents over 25 years of age, excluding graduate students. 21 Inthe early 199Os,an estimated 5000 Jamaicans were enrolled in US, UK and Canandian undergraduate and post graduate studies, including 2 year colleges (Buttrick, 1994). 22 Note that these migration figures suggest that the growth of human capital, which is typically estimated between censuses by graduation rates (for example Loayza, et al, 2002), i s substantially overstated for Jamaica(see also Section IV in Chapter 5). 63 rising real wages. As a result, investments previously made in these sectors, and in pre- crisis buildingconstruction, are now substantially underutilized and do not represent fully productive elements of the capital There i s also an issue that investments and salaries to deter crime do not contribute much to the national output as measured. GDP growth and investment in the latter half of the 1990s has been in natural resource-based sectors like tourism, transport, and bauxite, which have lost less competitiveness at the current exchange rate and wage rates.24 In these sectors, plus telecommunications, investment i s profitable and they have attracted most of the non-housing investment and the foreign investment in Jamaica.25 Even in these sectors there may be some underestimate of GDP growth. 2.44 The rate and characteristics of Jamaica's growth did not generate a rapid growth in employment. Only public sector employment has grown, private sector employment growth has been negative, because of the fall in female employment. The labor market also appears to be functioning imperfectly, with high wage demands depressing labor demand and probably generating some substitution o f capital for labor. 2.45 While average outcomes in education are poor and limit productivity gains, migration continues to be large, suggesting that tertiary education, in particular, performs relatively well. Migration offsets the potential improvement in the quality of the labor force, at least at the higher skill level (see Chapter 5). Canada, U S and UK actively recruit skilled Jamaican workers like teachers and nurses. High crime rates may be a factor contributing to migration. 2.46 High rates of emigration are likely to continue, as long as the U S and Canada continue to accept Jamaican graduates as immigrants. Moreover, such emigration raises the issue of the brain drain, and methods of recouping at least some of the large amount of public sector expenditure to educate these students (Chapter 5). 2.47 Generating higher growth in tradables i s the key to growth in Jamaica's open economy but i s likely to be difficult because of the country's high costs. Dependence on further growth inthe informal sector and further increases inpublic sector employment is not a viable strategy for improving economic performance. Yet expanding tradables will be difficult without tackling distortions. The impact of past exchange rate appreciation (despite significant real appreciation since 2002) and high wage increases in the 1990s continues to keep costs high compared to Asia or regional competitors. Capital costs are high because of the debt overhang and government demands for finance, and the high overheads necessitated by high crime rates and security costs. As a result, imports have substituted for most manufacturing production, other than that protected by transport costs, and some agro processing. Some exports do occur to the other Caribbean countries but that is a slow growing market. Other exports are to the niche market of Jamaicans overseas but, for instance, exports of Red Stripe beer pale incomparison to the success of Mexico's Corona. Export-oriented textile production shifted to the Dominican Republic, 23Calculations of the capital stock also need to reflect the damages from recent major hurricanes. 24In natural resource based sectors, higher wages and appreciated exchange rates reduce the incomes to the owners of the natural resources and the taxes that government can levy on their use. 25Some investors in these sectors may also have been attracted by tax concessions. 64 Honduras, Haiti, among others, and to Mexico after the formation of NAFTA (see Chapter 7),a loss in GDP of about 1percent. Banana and sugar exports are largely made possible by quotas given by importers that are gradually being reduced. Sugar i s largely a public sector operation and the attempt to privatize it collapsed because of the unattractive exchange rate, but some o f the private sector firms are said to have substantially lower costs. In other sectors, the attempts to take advantage of the good telecommunications and English language skills for IT-related industries run into high labor cost and the crime issue (night time workers need to be transported to and from their homes). The bauxite industry is still a major contributor to exports, but low world prices and the falling productivity of the old mines are reducing its dynamism. Tourism i s competitive because of the climate and beaches and it continues to bring in substantial foreign investment, even with higher wages, partly because much of the competition i s elsewhere in the Caribbean, which also has high wages in US$. However, the benefits that tourism brings are somewhat eroded by the subsidies and tax concessions offered by the government. The crime issue, or the perception that there i s a crime issue, also limits tourism growth. Indeed, in the second half of the 1990s, growth of tourism has slowed, and Jamaica has lost out to popular destinations such as the Dominican Republic. 2.48 Policies that improve international competitiveness and increase productivity are thus the key to growth in Jamaica's open economy. Improving competitiveness means wage growth much more in line with productivity; a reduction in crime to reduce its associated overhead costs; better customs services, so smaller firms can access imported inputs better; and a reduction in the tax and interest rate burden imposed by the public sector. A gradual nominal depreciation would tend to increase competitiveness: the pass through into prices i s likely to be limited by the weakness of the economy and low inflation in recent years, according to recent research. The resulting depreciated real exchange rate will reduce the local component of costs in US dollar terms and thereby stimulate output in agriculture, manufacturing and tourism. The events of 2003 have demonstrated that a real depreciation i s possible-in the first half o f 2003, the nominal exchange rate depreciated about 15 percent, but consumer prices rose about 7 percent, leading to a real depreciation of 11 percent. This real depreciation also demonstrates the enhanced credibility achieved by the central bank inrecent times, and that credibility will continue to be key to maintaining the gains in exchange rate competitiveness. It i s also important to note the while depreciation will benefit agriculture by raising prices of imported foodstuffs, it will hurt poor urban consumers and raise the burden of external debt. A one-time, step devaluation alone i s unlikely to sustainexport growth. Sustained growth in exports will depend on policies that generate a perception that exports will be kept profitable for some time and therefore investment in outward oriented production will pay-off. Finally, better infrastructure will also be needed. In addition to general infrastructure improvements, infrastructure will be needed to maintain tourism's dynamism and decisions will need to be made: a) whether to improve infrastructure in existing tourist areas or start new ones, and b) how to pay for it. Unless growth picks up, the demand for labor will continue to grow slowly and migration (labor export) will continue. 65 CHAPTER 3: REDUCINGTHE FISCAL AND DEBTBURDEN I. INTRODUCTION 3.1 Inthe early 1990s, Jamaica made considerable progress in its fiscal affairs. Tight fiscal policy was part of the overall macroeconomic strategy to stabilize the economy and stimulate economic growth. From 1990/91 to 1995/96, the government ran a fiscal surplus and a significant primary surplus (the difference between revenue and non- interest expenditure), although these surpluses declined over the period. These surpluses, plus Paris Club andbilateral debt restructurings, reduced the total public sector debt from US$5427 million (US$3942 million external) in 1990/91 to US$4435 million (US$3070 million external) in 1995/96; the ratio of debt to GDP declined from 138.3 percent in 1990/91 to 85.9 percent in 1995/96. 3.2 The financial crisis of the mid-1990s' together with the rising government wage bill and falling revenue over 1996/97 to 1997/98 (relative to GDP), have worsened the fiscal and debt position dramatically. It i s possible that the trends in revenue and expenditure would have worsened the debt position even without the financial crisis. However, in response to the massive financial crisis, the government replaced all of the financial institutions' weak lending with government debt. This policy protected the depositors, but generated a massive Government debt increase. The resulting interest costs, together with the deteriorating underlying balance, have reversed the fiscal gains of the first half of the 1990s and 1999/00-2000/01, even despite cuts in government investment that would have been desirable for growth. Recent domestic and external shocks have only served to exacerbate the already weak fiscal situation. 3.3 Primary surpluses of more than 10 percent of GDP are neededjust to sustain the current, high debt to GDP ratio o f about 150 percent. A lower primary surplus (6-7 percent of GDP) would only stabilize the debt if the debt were lower by some 50 percentage points of GDP. 3.4 Reaching fiscal and debt sustainability are critical to a return to sustained growth, hence the near-term challenge for the government i s to chart and maintain a transparent course to improved fiscal and debt indicators in what i s likely to be a less friendly external economic environment. 3.5 The chapter i s organized as follows: Section IIexamines the current fiscal situation as well as its evolution since the early nineties. Section I11analyzes the issues o f debt sustainability given the current structure of the debt and in the context of the current macroeconomic policy framework. Section IV briefly examines one of the imperatives o f fiscal policy going forward, viz., the challenge of reducing and improving government expenditure. This i s an area where more detailed analysis i s required, and will be taken up in the Bank's forthcoming Public Expenditure Review. Sector V deals with the other imperative of fiscal policy, viz., raisingrevenue in a weak economy with a large informal sector and where the tax rate i s already relatively high. Section V I looks at the legal and institutional framework for the management of fiscal policy and concludes that the legal andinstitutionalframework is essentially sound with needfor only fine-tuning. 11. THE GOVERNMENTBUDGET 3.6 Jamaica currently faces significant challenges in its fiscal affairs. The fiscal targets for 2002/03 were missed by large margins-the outturn for the central government deficit was 8 percent of GDP, compared with a target of 4.4 percent, and the primary surplus was 8 percent of GDP against a target of 10.4 percent. Given the increase in the total debt to about 150 percent points of GDP, and very low GDP growth, the fiscal deterioration poses significant challenges. 3.7 From a longer-term perspective, Jamaica's fiscal position has deteriorated significantly since the mid-l990s, interrupted b y an improvement from 1999-2001. The deterioration i s mainly the result of a) a massive rise in interest costs, much of it due to debt arising from the financial crisis and b) a nearly as large a rise in the wage bill. Government expenditures rose from 25.6 percent of GDP in 1994/95, to 32.6 percent in 1996/97 and then, after stabilizing at about 33 percent of GDP until 2001/02, rose sharply in 2002/03 to 37.6 percent of GDP. Meanwhile, revenues rose from 28.6 percent of GDP in 1994/95 to about 30 percent of GDP in 2000/01 and 2002/03 (although they deteriorated over 1996/97 to 1997/98). The worsening deficit and the corresponding worsening of the already high ratio of debt to GDP naturally have raised questions of debt sustainability. 3.8 Between 1991/92 and 1995/96, Jamaica's central Government's operations were in surplus (Figure. 3.1). Expenditures roughly tracked revenues. However, as a percentage of GDP, the fiscal surplus was falling because nominal GDP was growing somewhat faster than revenues due in part to high inflation. The overall public sector balance was in surplus. However, the Government surplus was preserved in 1995/96 only by postponing several expenditure items, which contributed to the deficit in the 1996/97 budget (1996 ESSJ). 3.9 In 1996/97, both the Government's interest costs and wage bill rose significantly, by 2.7 and 2.4 percentage points of GDP, and continued to rise in most years thereafter. Other non-capital expenditure also rose in 2001/02 and 2002/03, after being compressed for four previous earlier years. As a result of these trends, the government has increasingly been forced to borrow not only for capital spending but also current spending. 3.10 The rise in interest costs initially reflected a rising real interest rate. After 1996/97, interest costs also rose because of rising debt, as the Government absorbed the costs of the financial crisis including FINSAC debt (Table 3.1) and took on some other contingent liabilities. Adding to the concern i s that the 2 percentage points o f GDP increase in interest costs in 2002/03 came at a time when U.S. interest rates had fallen to thirty year lows. Partly the rise in 2002/03 is explained by the greater dependence on domestic debt, as domestic rates are higher in nominal terms than international rates. 68 Nonetheless, the sharp rise ininterest costs raises a concern that the Government i s facing a risingrisk premium for domestic borrowing. Figure 3.1: Jamaica: Fiscal Revenue and Expenditures by Type, 1991192-2002103 I 40 Expendibre 35 -2 a 30 25 C 20 a, $ 15 a 10 5 0 3.11 The rise in the ratio o f wages and salaries to GDP that began in 1996/97 reflected both higher real wages and the growth of employment (see Chapters 1 and 2). After a sharp increase in 1996/97, the higher ratio of wages to GDP was roughly maintained, despite continued growth in the public sector labor force, until 1999/00. In that year, the wage bill was lowered from 11.5 percent to 10.5 percent o f GDP, a figure that was maintained in 2000/01, contributing to the falling deficit and rising primary surplus. However, since then, the ratio of Government wages and salaries to GDP has increased about 1percentage point of GDP per year. Inpart, the recent increases reflect the policy of raising civil service wages to 80 percent of comparable private sector wages, but there has been no offsetting reduction in overstaffing. The net result i s that Government wages and salaries are now nearly 6 percentage points of GDP higher than they were in 1994/95 (over 8 percentage points higher compared to 1992/93). 3.12 Wages and salaries have increased from less than 30 percent of expenditure in the first half of the 1990s to nearly 34 percent of (a much higher) expenditure today. Interest costs have risen from about 33 percent of expenditure in the first half of the decade to nearly 42 percent of (a much higher) expenditure in 2002/03. 3.13 Meanwhile, the Government has reduced its investment (as a percentage of GDP) to offset partially the rise in wages and salaries and in interest costs-a crowding out of investment within the budget (Figure 3.1). Government capital expenditures have fallen from over 4 percent of GDP in the first half of the 1990s (and over 5 percent between 1995/96 and 1997/98), to only 2 percent of GDP today, that is, from about 17 percent of total expenditure in the first half of the decade to only 5 percent currently. And, while the Government debt has not crowded-out overall investment much, in terms of the overall investment ratio, the increased availability of government debt and the 69 segmentation of the credit market has probably affected small borrowers, who are riskier and unable to access foreign markets (see Chapter 4 for further discussion). Table 3.1 Jamaica Fiscal Operations 1992193 -2002103(%Of GDP) 92/93 93/94 94/95 95/96 96/97 97/98 98/99 99/00 00101 01/02 02/03 Central Government Balance 3.7 3.0 3.1 1.8 -6.3 -7.6 -6.9 -4.2 -0.9 -5.7 -8.0 Revenuesand grants 27.3 28.3 28.6 28.3 26.4 25.4 26.6 29.8 30.0 27.6 29.6 Tax 1/ 24.0 25.8 26.0 25.7 24.3 23.7 25.0 26.9 26.7 25.0 26.4 Non-tax2/ 2.2 2.1 1.8 2.1 1.7 1.4 1.3 2.7 2.8 2.1 2.9 Grants 1.1 0.4 0.9 0.6 0.4 0.3 0.2 0.3 0.5 0.5 0.2 Expenditures 23.6 25.3 25.6 26.5 32.6 33.0 33.5 34.0 31.O 33.3 37.6 Wages and salaries 4.6 8.7 7.2 7.7 10.1 11.1 11.5 10.5 10.5 11.5 13.0 Interest 8.0 8.3 9.6 8.7 11.4 9.4 12.4 13.8 12.8 13.7 15.7 Domestic 4.2 5.0 6.6 6.0 8.9 7.2 10.2 11.6 10.2 10.9 11.8 External 3.7 3.3 3.1 2.7 2.5 2.2 2.2 2.2 2.6 2.9 3.8 Other expenditures31 5.6 4.2 5.0 4.7 5.5 7.5 6.9 6.6 5.0 5.4 6.9 Capital expenditures 5.4 4.1 3.8 5.4 5.6 5.0 2.7 3.0 2.8 2.7 2.0 Rest of publicsector balance -1.6 -0.1 0.7 0.2 0.9 -1.6 -4.0 -3.0 -4.7 -1.1 -1.3 Operating balanceof public enterprises 3.0 1.6 2.7 -0.4 0.3 0.8 1.3 1.1 0.4 0.5 1.3 FWFINSAC balance41 0.0 0.0 0.0 0.0 -0.3 -2.1 -5.2 -4.4 -4.6 0.0 0.0 Bank of Jamaicaoperating profitlloss -4.6 -1.7 -2.0 0.6 1.0 -0.3 0.0 0.3 -0.5 -1.7 -2.5 Total publicsector balance 2.1 3.0 3.8 2.0 -5.3 -9.2 -10.9 -7.2 -5.6 -6.8 -9.3 Externalfinancing -0.7 0.7 0.5 -1.5 -0.9 1.1 -0.8 -1.2 3.6 7.0 -3.3 Domesticfinancing -1.5 -3.6 -4.2 -0.6 6.2 8.2 11.7 8.4 2.0 -0.1 12.6 Bankingsystem -2.7 -4.3 -1.4 3.5 -1.2 18.6 8.4 2.7 4.2 7.8 8.1 Others 1.3 0.6 -2.8 -4.1 7.4 -10.4 3.3 5.6 -2.2 -7.9 4.5 Adjusted central government balance51 3.7 3.0 3.1 1.8 -6.3 -8.7 -12.3 -8.3 -5.5 -5.7 -8.0 Central government primary balance 11.6 11.4 12.7 10.5 5.2 1.8 5.5 9.6 11.8 8.0 7.7 Public sector primarybalance 14.6 13.0 15.4 10.2 5.4 2.6 6.8 10.7 12.2 8.6 8.9 Memorandumitems: Non-financialpublic debt (end of period)6/ 114.0 122.5 110.1 85.9 79.1 102.3 115.7 132.7 131.9 130.6 148.5 Domestic 21.5 19.9 32.6 26.4 35.4 59.3 73.1 90.0 83.6 78.2 89.8 External 92.5 102.6 77.5 59.5 43.7 43.0 42.6 42.8 48.3 52.4 58.8 Source: IMF Notes: 1/ Includesbauxitelevy 2/ Includescapital revenue 3/ Includesstatisticaldiscrepancy 4/ Includesinterestdue and capitalizedduring the year up to 2000101 51 IncludesFINSAC interest paymentson a full year basis 61 The public sector debt is defined to include central government domestic and external debt and domestic and external debt guaranteedby the government. It excludesgovernmentsecurities held by public enterprises and externaldebt held by BoJ. Note: Figuresfor 2002/03 are preliminary. 70 111. TOWARDS SUSTAINABLEDEBT 3.14 The rising ratio of debt to GDPinJamaica raises questions of its sustainability. In 1996197, Jamaica had a Government debt to GDP ratio of 79 percent, already a fairly high ratio by international standards.' However, the financial crisis, the economic contraction, and the increasing fiscal deficits and the resulting increased borrowing have led to a sharp rise in debt, relative to GDP. In particular, the fiscal cost o f the financial crisis exacerbated the adverse debt dynamics so that by 2000, debt was about 130 percent o f GDP (Table 3.1 and Figure 3.2). Most of the increase in debt was domestic, replacing private credits in the banks, and today Government debt i s the counterpart of more than half of Jamaican banks' deposits, as discussed in Chapter 4. By 2002, fiscal tightening and greater reliance on offshore borrowing (which i s less costly in the context of an appreciating real exchange rate) had reduced the ratio of debt to GDP slightly. However, with the significant fiscal slippage in 2002/03, depreciation in the exchange rate, and higher interest rates, the ratio of debt to GDP rose to nearly 150 percent o f GDP, one of the highest ratios in the world, with domestic debt about 90 percent of GDP and external debt about 60 percent of GDP.2 3.15 The structure and composition of debt has changed significantly since 1991 (Table 3.2). The share of domestic debt in total debt has risen from 8.3 percent in March 1992 to 60 percent at the end of March 2002, owing in large part to the financial crisis and its ensuingimpact on the deficit. Initially, most of the increased domestic borrowing has been through Local Registered Stocks (LRS) and Treasury Bills. LRS stocks rose from 61 percent of domestic debt in March 1992 to 72 percent by March 2002. Treasury Bills issuance reduced after 1994/95, and their share in domestic debt fell from 27.3 percent in March 1992 to 5.4 percent in March 2002. As the domestic capital market developed in the mid-nineties and the government moved to lengthen the term structure of its domestic debt, long-term bonds became more important. Consequently, the share of bonds increased from about 4 percent inMarch 1995 to 21.4 percent inMarch 2002. 3.16 Apart from this, the Jamaican banking system, which i s emerging from the financial crisis of 1995/96, has more than one-third of its assets consisting of Government debt (which, net of Government deposits, represented about 45 percent of deposits in banks in June 2003, see Chapter IV). The rest of the financial system (merchant banks, brokers, buildingsocieties) also has a large holding of Government debt. 3.17 The share of external debt has fallen from 91.7 percent in March 1992 to 40 percent in March 2002. Its structure has also changed, with the share of concessional debt (bilateral and multilateral) falling from 85.5 percent in 1991/92 to 52.6 percent in ' In 1991/92, the debt to GDP ratio rose to 181 percent, from 138 percent in 1990191, owing to the significant depreciation of the exchange rate from J$8.4 per U S dollar in 1990/91 to J$24.8 in 1991/92. The external debt stock in US dollar terms actually fell from US$3,942 million in 1990/91to US$3,787 million in 1991/92, but rose from 100 to 163 percent of GDP. The decline in the debt ratio to 79 percent in 1996/97 was achieved through: debt reduction under the Enterprise for the Americas Initiative, debt cancellations from the British and Netherlands Governments, and debt rescheduling under a Multi-Year *Rescheduling Arrangement with the Paris Club, in 1991and 1993. Note that external debt figures do not include short-term external debt. 71 2001/02. Reflecting increased access to the international capital market, the share of private creditors in total external debt grew from 14.5 percent in 1991/92 to a high of 47.4 percent in 2001/02 (Table 3.2). It i s also noted that bonds accounted for the bulk (40 of 47.4 percent) of the share of private creditors. Table 3.2: Jamaica Domestic and External Debt. and Structure of External Debt, 1991/92 2001102 - - 1991/92 1994/95 1995/96 1996/97 1997/98 1998/99 1999100 2000101 2001102 Total Debt J$Mn 113,041 170,807 193,843 198,205 219,214 262,303 308,688 380,641 497,083 Domestic Debt J$Mn 9,359 50,139 57,675 85,181 101,540 139,204 175,323 215,084 300,201 %Share 8.3 29.4 29.8 43.0 46.3 53.1 56.8 56.5 60.4 External Debt US$Mn 3,786 3,612 3,402 3,223 3,223 3,216 3,165 3,624.27 4,135.29 %Share 91.7 70.6 70.2 57.0 53.7 46.9 43.2 43.5 39.6 Share of External Debt (%) Multilateral 35.5 35.9 35.3 33.1 35.0 33.0 32.3 30.7 27.3 Bilateral 50.0 52.6 53.3 53.2 45.3 44.2 41.9 31.8 25.3 Private Creditors 14.5 11.5 11.4 13.8 19.6 22.9 25.8 37.5 47.4 CommercialBanks 9.0 8.5 8.7 8.7 8.8 4.8 4.3 4.2 2.2 Other 5.5 2.9 2.7 1.9 1.5 0.9 1.2 5.6 5.2 Bonds 3.1 9.3 17.1 20.4 27.8 40.0 Source: Ministryof Finance Figure 3.2: Jamaica: Total Public Sector Debt to GDP (includingGovt. guaranteeddebt) Source: IMF; See Table 3.1. &Public 1 Debt 3.18 Reaching fiscal and debt sustainability are critical to a return to sustained growth, but primary surpluses of more than 10 percent of GDP are needed just to sustain the current, high debt to GDP ratio of 150 percent. Table 3.3 (which shows the debt- stabilizing primary surplus under alternative assumptions about interest rates, inflation, growth3) shows that this i s the case under plausible future scenarios for growth and interest rates (for example, growth of 2 percent, nominal interest of 18 percent and I t should be noted that these projections assume that Jamaica will not be subject to adverse shocks, such as those it has had to contend with since the events of September 11, 2001. Adverse shocks could erode confidence and put pressure on the currency and upward pressure on interest rates, both of which would increasethe level of debt. 72 inflation of 8 percent). Moreover, the required surplus i s extremely sensitive to growth and interest rates, and it i s worth noting that the Government inJune 2003 floated 2 and 5 year LRS at about 34 percent (implying a real rate of about 25 percent). For example, given the stock of debt, a 1 percentage point increase in the nominal interest rate increases the required primary surplusb y about 1.4percentage points of GDP. Similarly, an increase in growth by 1 percentage point would reduce the debt-stabilizing primary surplus by about 1.5 percentage points of GDP. As the table also shows, it is possible to trade off higher inflation for a lower primary surplus, but this depends on limited movement in the interest rate-if the interest rate rises with inflation, then there i s no tradeoff. Table 3.3: Primary SurpluslDeficit (?lo requiredto Stabilizethe Stock of Public Debt of GDP) Note: g: real growth rate; d: debt to GDP ratio; i: nominal interest rate; f: inflation. Source: World Bank staff estimates 3.19 The debt stock i s also sensitive to the exchange rate, given that external debt i s about 60 percent of GDP, and about 20 percent of domestic debt i s indexed to the U S dollar. In the simple model above, the initial exchange rate is factored in through changes in the initial debt to GDP ratio. A rough rule of thumb i s that a 1 Jamaican dollar depreciation in the J$ versus the US$ results in an increase in total debt by 1 percent of GDP. To mitigate this, real exchange rate depreciation (which will help improve competitiveness) would need to be accompanied by growth and productivity enhancing measures, and preferably reduction inreal interest rates. 3.20 Reducing the debt stock will of course demand higher primary surpluses. Inorder to meet its target of reducing the debt to about 123 percent of GDP by the end of 2005/06, higher surpluses of about 15-17 percent of GDP will be needed (assuming 2 percent growth, interest rates of 15-17 percent, and inflation of 8 percent). 3.21 Fiscal slippage, to a primary surplus of 6-7 percent of GDP, would lead to a rise in the debt to GDP ratio. A primary surplus of 6-7 percent of GDP, would, under assumptions mentionedearlier (growth 2 percent, interest 18 percent, inflation 8 percent), only stabilize debt if the debt were lower b y some 50 percentage points of GDP. Such surpluses, while still high, would be more manageable. Lower required surpluses could free up resources for critical economic and social investment, crowd-in private investment and create a virtuous growth cycle that would further improve debt dynamics. 73 3.22 To summarize, the current debt of about 150 percent o f GDP needs primary surpluses of over 10percent of GDPjust to stabilize the debt, at interest rates much lower than the ones currently prevailing. Reduction of the debt to 123 percent by 200906 would further increase the required surpluses. A lower primary surplus (6-7 percent of GDP) would only stabilize the debt if the debt were lower by some 50 percentage points of GDP. IV. REDUCINGAND IMPROVINGGOVERNMENTEXPENDITURE 3.23 A key element in reducing Government expenditure is control over the wage bill, which now accounts for over a third of Government expenditure. Rising real public sector wages are inconsistent with a sustainable debt ratio and a slow-growing economy, unless public sector employment i s reduced, in percentage terms, by more than the real wage increase. Allowing real public sector wages to fall may provide a temporary reduction in the growth of public wages and salaries, but it i s not a sustainable way to reduce wage and salary expenditure relative to GDP. Typically, falling real public wages and salaries generate political pressure for an increase and, once the catch-up i s granted, the ratio of public wages and salaries to GDP returns to, or even exceeds, the original level. 3.24 The four major ministries of Finance, Education, National Security and Health accounted for over three quarters of the total public sector employment and 90 percent of recurrent expenditure in 2001/02, up from 82 percent in 1991/92. Therefore, attempts at controlling or reducing total recurrent expenditure would need to focus on these key ministries. However, this i s a complex issue that bears detailed investigation. For example, the nine-fold increase in the budget of the ministry of national security reflects the response to the increased levels of crime since the mid-nineties. As a result, the strength of the police force has increased by 1068 since 1991 to 7,033 in 2000. Over the same period, the number o f registered nurses in the health ministry increased by only 330. Any attempt at reducing or controlling expenditure in the public sector must necessarily focus on the details of the expenditures within each ministry vis-&vis the specific mandate of the ministry. In addition, it may be possible to rationalize some functions across ministries. For example, it may be possible for some ministries to outsource some specialized services such as auditing or procurement. While more work i s needed on this (to be taken up the Bank's forthcoming Public Expenditure Review), it would appear that significant reduction in public sector employment would need to be accompanied by organizational and efficiency gains. 3.25 The government has made progress on the privatization agenda but the experience has been mixed (see Box 3.1) and the government still has substantial holdings in some entities, including Air Jamaica4, mining companies, the power company and the sugar The Government recently re-acquired Air Jamaica, which was privatized in 1994 and in which the government retained 30%. Before the re-acquisition in 2003 the government had provided several guarantees for loans to the privatized entity. Indeed, by 2000 the government had injected about US$133 million into the privatized airline and had increased its share to 45 percent. 74 industry. Inaddition, there are a number of relatively small enterprises that remain inthe public sector in activities such as agriculture and tourism, which could be transferred to the private sector. The proceeds from the sale of shares or privatization of these entities could be used to write down the debt, although the proceeds are likely to be much smaller than in the past. In addition, the transfer of the entities to the private sector could reduce the risk of contingent liability even though it would not eliminate it, as the case of Air Jamaica has proved. 3.26 Achieving a more sustainable debt burden and improved Government expenditure will depend not only on lower public expenditure, but more public investment within that expenditure, focused in sectors that are critical for creating the enabling environment for private sector investment and growth. Government expenditure has increasingly become current expenditure, as noted above. However, development depends to some degree on more infrastructure investment. Cross-country evidence suggests that infrastructure tends to encourage ("crowd-in") private investment. O f course, such infrastructure investment can be financed by reasonable user charges or other revenues linked to debt servicing, allowing the Government, or a public entity, to repay the debt taken to carry out the investment. 3.27 While private investments have substituted for some traditionally public infrastructure in Jamaica, notably telecommunications, power and more recently toll roads, public infrastructure investment will be important in stimulating growth. Inrecent years, the government's capital investments have been focused on roads and water supply but significant investment has also been made in the information technology and tourism sectors. Table 3.4 gives the sectoral shares in the government's planned Public Sector Investment Program up to fiscal year 2003/04. Economic infrastructure has been accorded high priority, getting over 50 percent o f the total investment. Included in this are significant investment in major roads (maintenance, rehabilitation and new construction); airports (including investments pursuant to the divestment of the Sangster's airport) and seaports. In an effort to finance priority infrastructure, the government has also resorted to "deferred financing", where private contractors are asked to arrange their own financing for government projects on which they bid, thus avoiding a direct budget outlay. However, this creates contingent liabilities for future budgets. 3.28 The government's social investment has been focused on education and housing. Other social infrastructure, which includes a significant outlay for the Lift Up Jamaica Program and the Social and Economic Support Program (SESP), account for a major share of social investment. Given the current tight budget, the government may need to review its investments in housing given the involvement of the National Housing Trust and a fairly well developed mortgage market. 75 Box 3.1: A Tale of Two Privatizations Jamaica's privatization program began in 1981 as part of a general effort to reduce the role of the government in the economy. However, privatization as part of a more distinct strategy of liberalization and private sector led growth started in the mid eighties. This box highlights two privatization experiences in Jamaica-the sugar industry, which despite significant preparatory work was considered a failure; and the telecommunications company that, in spite of initial problems, is considered an overall success. Privatization in the sugar industry In 1994, a private sector consortium, including the transnational Tate & Lyle, a local merchant bank and a local distillery group, acquired the majority stake of the Sugar Company of Jamaica (SCJ). The government retained minority participation through the holding of 49% of the shares. The sale of the mills was highly transparent and all stakeholders were fully informed of the process of privatization. It was envisaged that privatization would lead to lower production costs through improvements at the field and factory levels. However, in October 1998, approximately four years after privatization, the Jamaican government re-acquired the SCJ, due in part to the financial crisis and the heavy debt carried by the company. The re-acquisition made the government once again the major player in the sugar industry. The failure of the sugar industry under private ownership has in large measure been blamed on the revaluation of the exchange rate in 1997. Government's retention of a significant share (49 percent) after privatization may have also weakened the incentives for the private sector to persevere in pursuing the tough reform measures that may have been necessary to turn the industry around. The fiscal cost of the re-acquisition (with working capital deficiency of over J$3 billion or 1 percent of GDP) and operations of the sugar mills has beensignificant Privatization in the telecommunications industry In 1988, the Government of Jamaica privatized the provision of basic telephone services with the sale of licenses to Cable and Wireless Jamaica Limited. I t is clear that not enough attention was paid to the establishment of an adequate regulatory framework. Perhaps in its effort to maximize revenue or woo investors, Jamaica granted the privatized telephone company a twenty-five year concession on local and competitive international services that guaranteed a rate of return exceeding industry norms. Notwithstanding the regulatory issues, there were many gains from the privatization in the telecommunications sector. The most immediate gain was the significant investment by the monopoly C&W to expand service in the sector. After liberalization in March 2000, mobile phone accounts grew from 144,000 to 1.2 million by 2002, and penetration rates were higher than several developed countries. In March 2003, the sector became open to competition in all aspects of telephony. The macroeconomic impact of the privatization and liberalization of the telecommunication sector has been quite considerable. Since the liberalization of the sector, more than US$400 million has been invested. The reduction in the local telecommunication cost facilitated the development of several IT related services and has reduced at least one of the disadvantages faced by Jamaican firms (see Chapter 7). LessonsLearned These two episodes of privatization with sharply contrasting results, along with privatization experiences around the world, highlight three potent lessons for future privatization: (1) the necessity to create incentives for the private sector to take full control, which avoids the creation of contingent fiscal liability for the government, either through occasional bail-outs or through the outright re-acquisition of the privatized entity; (2) the importance of a predictable planning environment for the private sector (the revaluation of the exchange rate in 1997 must have been a major shock for the new investors in the sugar industry); and (3) the importance of carefully considering the regulatory framework a priori, to encourage early competition that would enable reaping of the larger economic benefits of competition. The overall fiscal benefits of early competition may outweigh the one-time gains to revenue of a sale with regulatory concessions. Table 3.4: Jamaica Public Sector Investment Program, 2000/01 2003/04 - (percentage share by sectors) 2000101 2001102 2002103 2003/04 Directly Productive 3.2 4.3 4.3 3.5 Agriculture 2.3 2.7 2.8 2.1 Mining 0.04 0.1 0.1 0.1 Tourism 0.9 1.6 1.4 1.4 Economic Infrastructure 52.6 58.8 39.9 27.6 Transport & Communication 27.8 23.2 12.1 8.5 Power & Energy 6.1 13.4 7.3 7.1 Water Supply & Sewage 5.5 5.1 6.4 4.3 Other Economic Infrastructure 13.2 17.0 14.1 7.6 Social Infrastructure 24.8 25.6 30.0 26.9 Education 5.4 5.9 8.1 4.8 Health 1.4 0.8 1.7 1.3 Housing 7.5 . 8.2 8.6 10.6 Other Social Infrastructure 10.4 10.7 11.7' 10.2 Administration 18.9 10.2 23.4 40.5 Total PSlP excl. on-lending 99.5 99.0 97.6 98.5 Funds & Loans 0.5 1.o 2.5 1.5 Total PSlP and on-lending 100.0 100.0 100.0 100.0 Source: Jamaica Medium Term Strategy, Planning Instituteof Jamaica V. RAISINGREVENUE:TAXES AND USERFEES 3.29 Revenues are about 27 percent of GDP (taxes about 25-26 percent of GDP and non-tax revenue about 2-3 percent of GDP). Compared to other developing countries, Jamaica has a fairly high revenue base, particularly compared to Latin American countries (Table 3.5). The distribution of revenue i s shown in Annex Table 3.3. Forty percent of tax revenue comes from income and profits taxes, which have been about 10 percent of GDP in recent years. O f the income and profits taxes, more than half comes from withholding tax on incomes (PAYE) and about 20 percent from withheld taxes on interest. About seven percent comes from taxes on profits of companies, which have been Table 3.5: Government falling steadily as a percentage of GDP since the RevenueslGDP mid-1990s. The Education tax, 1 percent o f Selected Countries,2000, YO GDP, is also a kind of withholding tax that is New Zealand (1999) 32.9 paid by employers on the wage bill. The Barbados 32.7 General Consumption Tax (GCT, Jamaica's Singapore 32.7 version of the VAT) produces 7 percent of Jamaica 27.0 GDP, nearly 40 percent from imports. Mauritius 21.4 However, the GCT has declined nearly one Dominican Republic 16.1 percentage point o f GDP since the mid-1990s. Costa Rica 12.2 The Special Consumption Tax (SCT) (imported El Salvador 12.1 goods) accounts for nearly 3 percent of GDP. Source: IFS. IMF. 77 Tariffs still account for about 2.5 percent of GDP, and the bauxite levy has fallen to 0.4 percent of GDP reflecting lower levels of production as well as lower prices. Capital revenues have been erratic reflecting the fortunes of both the financial performance of the selected public sector entities and the government's divestment program. 3.30 Given the already high tax rate, revenue measures have increasingly focused on (a) increasing compliance through plugging the loopholes in the tax system and (b) increasing user fees to reflect the economic cost of providing government services. 3.31 Since the early 1980s, Jamaica's tax system has undergone significant reform in order to achieve the multiple objectives of simplicity, equity, and effectiveness and to make the system more capable of stimulating investment and economic growth. There has been significant simplification of personal income tax, moving from a marginal rate of 57.5 percent in 1980 to a flat rate of 33.3 percent in the mid-eighties, and then to a flat rate of 25% (as well as a minimum exempt income level) currently. The GCT, the Jamaican version of the value added tax, was put inplace in 1991. 3.32 The growth of the informal sector, inpart, to avoid taxes, has tended to reduce the tax base. For example, the growth of the informal sector probably has contributed to the decline in the GCT as a percentage of GDP. The question i s how best to bring the informal sector into the tax net, in order to level the playing field between informal and formal firms. As noted above, most of the tax revenue comes from withholding taxes or taxes on external trade, which firms in the informal sector bypass. Reducing the GCT rate i s unlikely to bring enough firms into the tax net to offset the loss of revenue from lower rates. Further simplification of the tax system, including the merger of some taxes such as the Education Tax and the National Housing Trust Tax with income tax may provide an additional incentive for more small informal sector business to come into the tax net, as their transaction cost for tax compliance would be much lower. 3.33 Through amendments to the Revenue Administration Act and the introduction of the Taxpayer Registration Number (TRN) system, considerable progress has been made inincreasing the number of registered taxpayers. However, this registrationhas been on a purely voluntary basis and may exclude many who operate in the informal sector. One approach to increasing the coverage of the informal sector, as well as to increase the revenues from personal income taxes, would be to use a system of indicators, such as motor vehicle licenses and overseas trips, to identify individuals who are not in the tax net. However, this will imply increased costs of tax administration. 3.34 Recent work by Artana and Navajas (2002) has pointed to a number of areas in which the design of the tax system could be improved, including: 0 the multiple tax rates and exemptions for GCT, which cannot be explained by equity reasons and which impose significant administrative burdens. 0 the tax bias infavor of debt financing relative to equity financing. 78 0 the additional payroll taxes including HEART, NHT and Education Tax which impose further taxes on labor and which may encourage firms to use labor saving technologies in an economy where unemployment and informality i s high. 3.35 Significant subsidies exist in the tax code. For example, the Investment Tax Credit means that some firms do not pay their share of taxes, and this may generate misallocation of resources. Firms receiving the Investment Tax Credit receive benefits that may reduce the cost of purchasing an asset by 20-40 percent, compared to other firms. Moreover, beneficiary of the Investment Tax Credit also i s allowed to depreciate 100percent of the asset's purchase price, a further subsidy. 3.36 A particular concern relates to the tourism sector, where firms may receive subsidies and ad hoc exemptions from taxes. Agreements between the Caribbean countries have attempted to limit these incentives to potential investors in hotels. However, in practice, it appears that investors still receive incentives, setting up a competition between countries that reduces their ability to generate returns from their valuable natural assets. 3.37 Significant opportunities exist to raise non-tax revenues, notably fees for tertiary education. As discussed in Chapter 5, fees are relatively low, especially given the high quality of the education. About 80 percent of the graduates emigrate (Chapter 2), depriving the Government of the possibility of recouping even part of the subsidy from income taxes. Although most of the graduates are from middle or upper income families, a system of fellowships and loans will need to be created to ensure access by poorer students. 3.38 If the government is to bringabout the fiscal adjustment necessary to reverse the adverse debt dynamics, the government may need to increase tax revenues to about 30% of GDP over the next five years or so. Compliance on GCT has improved over the last few years with the introduction of the tax reform program but compliance on income tax i s lagging, partly due to the large size of the informal sector. Tax revenue could therefore be increased without raising the tax rate if more o f the informal sector i s brought into the tax net. Compliance may be improved through further simplification of the tax system and through the abolition of some tax incentives as well as some exemptions. In its 2003/04 Budget presented in April 2003, the Government has attempted to raise significant additional tax revenue amounting to about 3 percent of GDP, targeting increased taxation of imports and vehicles, and a widening of the GCT base. VI, FISCALINSTITUTIONSAND GOVERNANCE 3.39 Jamaica is considered to have a sound legal and institutional framework for fiscal management. Two recent studies rank Jamaica as the best (Alesina et al, 1996) or the second best (Stein, et al, 1998) inthe region, in terms of its fiscal institutions. 3.40 The overarchinglegal framework is the Constitutionbut there are other key pieces of legislations such as the Financial Administration and Audit Act (FAA), the Public 79 Bodies Act. The consolidated Fund i s entrenched in the Constitution o f Jamaica.' The law requires that all the revenues collected by government be placed in the Consolidated Fund.This provision gives the government full control of the revenue inflows. 3.41 Sections 115 and 116 of the Jamaican Constitution deals with the budget including the responsibility for the. Estimates of Expenditure and the authorization of expenditure. The Constitution authorizes that estimates for each new financial year be presented to Parliament before the end o f the ongoing financial year. The Constitution also specifies that the estimates of expenditure must be separated into "statutory expenditure", mostly debt service,6 and money needed for other expenditure to be met from the Consolidated Fund. The Constitution further states that statutory expenditure must not be voted on by Parliament and must be paid out of the Consolidated Fund without further authorization by Parliament. Consequently, debt servicing has a first call on revenues and i s neither under the discretion of the Minister o f Finance nor Parliament. 3.42 Section 117 of the Constitution deals with the control of expenditure from the Consolidated Fund.The section states, inter alia, that money must not be paid out of the Consolidated Fund without a warrant (written authorization) from the Minister of Finance. In addition, for further control, the section provides that the Finance Minister can only authorize expenditure out of sums of money granted by the Appropriation Law for items of expenditure lawfully charged to the Consolidated Fund. This applies to all cases of expenditure with the exception o f (a) payments for debt service, including interest and amortization and (b) advances from a contingency fund which has been established by law. 3.43 In sections 120,121 and 122 of the Constitution, provisions are made for the establishment of the office of the Auditor-General (AG), including the terms of appointment, the tenure of office and the functions of the Auditor-General. The Auditor- General's function i s to examine and report on all government accounts at least once per year. The Auditor-General i s to report directly to the speaker of the house.' The independence of the Auditor-General i s Constitutionally established in Section 122 (3) of the Constitution. However, the AG's department may be considered to be lacking independence in two regards: (i) the budget of the AG department passes through the Ministry of Finance and Planningbefore submission to the legislature, and (ii) control of personnel actions i s substantially maintained by the Public Service Commission (World Bank, 2001a). 3.44 The Public Accounts Committee (PAC) of Parliament also plays a critical role in the audit process. The PAC consists of nine members of Parliament and i s chaired by a This section of the Constitutionrequires atwo-thirdsmajority inParliamentto change it. This includes any expenditure which the Constitutionsays must be met from the Consolidated Fundor from the general income and assets of Jamaica, and any payment made to service the public debt and any money set aside for the repayment of debts (sinking fund, or that money which is set aside for the gradual repayment of debts, also redemption monies, monies to be recoveredby agreed, regular payments) and all other costs involvedinthe managementof the public debt. The Auditor General's departmentitself is audited by the Ministry of Finance and Planning, in accordance with section 122 (4) of the Constitution. 80 member from the opposition. The Public Accounts Committee considers reports of the Auditor-General on the accounts of the Government and other organizations that are within the purview o f public audit. It may invite the Accounting Officer of ministries to attend public hearings to give explanation, evidence or information. Following the hearings, the PAC presents an annual report to Parliament. 3.45 The Financial Administration and Audit Act expands and clarifies Chapter VI11of the Constitution dealing with Finance and provides the legal framework for the management of funds appropriated (Le. approved) by the House of Representatives. The BudgetProcess 3.46 The budget processkycle in Jamaica i s controlled by the Ministry of Finance and Planning and involves a number of steps, illustrated inBox 3.2. 3.47 A recent assessment of the budgetary process by the World Bank Country Financial Accountability Assessment (CFAA), 2001 confirms the strength of the budgetary process but also points out some adjustments that would improve efficiency and transparency.* These adjustments include: (i) reducing the overlaps and duplication of functions and dispersion of oversight and policy-making responsibilities within departments dealing with the budget process; (ii) reducing the complexity of the current Program budget format to increase transparency and usefulness of the estimates; (iii) strengthening the government's corporate planning process, and integrating it into the budget process; and (iv) clarifying the classification of capital expenditure that is now classified as recurrent expenditure because ministries do not include such expenditures in the post-completion plan of projects; and (v) improvement in the transparency of cash management. 3.48 Inaddition, the current use of Cash Basis Accounting provides a limited picture of financial activity that could adversely affect the decision-making process. A switch to accrual accounting would reduce these risks. 3.49 The CFAA also found incomplete recording of assets and liabilities, and a lack of financial management guidance. Two key constraints also exist in the efficient and effective reporting of the use o f public resources (KPMG, 1999). First, the time gap between high level and detailed information. The aggregated results for revenues, expenditure and liabilities are available immediately after the fiscal year ends, but the details are not available until twelve months after. Second, delayed reporting of actual transactions. Actual expenditures are usually recorded a year after they occur. The use of estimates as opposed to actual amounts prevents holding the ministries fully accountable for the financial results. 3.50 In its assessment of the auditing of government activities, the CFAA was generally positive as many of the recommendations from the Cowater Study regarding the auditing of government departments were being implemented. In respect of the * See alsoKPMG, 1999. 81 Auditor General's Department, the CFAA indicated that its capacity and its independence were two o f the more important remainingissues to be tackled. 3.51 In addition to issues of prudent management of expenditures, management of direct and contingent liabilities i s also important. Explicit and implicit contingent liabilities have also been created by the government on its own behalf or on behalf o f other public sector entities or even entities that have been privatized. These contingent liabilities have caused budgetary problems, and include debt write-offs for the National Water Commission (approximately J$6billion), the Coffee Industry Board (J$2.7 billion) and the Sugar Industry (J$600 million) as well as guarantees of about J$9 billion of domestic debt. More recently, in May 2003, a J$6.3 billion loan external loan (90m euros) was guaranteedby the Jamaican Government for the sugar industry. 3.52 Management of the overall fiscal balance i s also made difficult by the lack of monitoring and reporting of non-central governments accounts on a timely basis. The CFAA noted that the GOJ budget only includes about 50 percent of the 140 public enterprises and that not all public enterprises are monitored. Since the central government i s ultimately responsible for the debt or other liabilities of non-central government accounts, incomplete reporting of such accounts increases the difficulty o f managing the fiscal balance. 3.53 Inmovingtowards achieving and maintaining fiscal stability, there is need for the government to establish a budgetary planning framework that identifies and classifies the full range of fiscal liabilities, both direct and contingent, as well as the associated risk. See, for example, the fiscal risk matrix developed by Polackova et al, 1999 and illustrated in Table 3.6 above. The establishment of the Jamaica Deposit Insurance Corporation (JDIC) addresses directly the implicit contingent liability related to banking failure, although there remains the issue of funding it promptly in the event that its own resources are drawn down. Some provisions have also been made for the contingent liability associated with Bank of Jamaica losses. However, there i s need for provisions related to contingent liability from riots, floods and hurricane damages as well as contingent liabilities from non-central government operations (National Water Commission (NWC), Air Jamaica etc.). 82 Box 3.2 THE BUDGETPROCESS Economic & Financial ProgrammeDevelopment 17 Parliamentreviews records ExpenditureCeilingSet ThroughPAC t 1 16 3 Auditor General Audit Budget Callissuedto Records& PresentsAudit to Ministries t Parliament 15 4 DepartmentReceiveFunds DraftBudgetreturnedto & RecordExpenditure MOF t 1 14 5 Accountant Generalreleases ReviewProcessinMOFP "`f 1 13 6 Ministryof Finance Follow up Issues Meeting with Warrants Ministries t 1 12 7 Par1iament DraftBudget Approves Finalized& t AppropriationBill Submittedto Cabinet . 11 BudgetDebate Cabinet Draft Budget 10 9 StandingFinance BudgetTabled in CommitteeExaminesthe Parliament Budget 83 Table 3.6: FiscalRiskMatrix Liabilities Direct Contingent (obligation in any event) (obligation if a particular event occurs) Explicit Foreign and domestic sovereign Central government guaranteesfor borrowing (loans contracted and non-sovereign borrowing and Government liability as securities issuedby central obligations issued to local recognized by law or government) government and public and private contract sector Budget of the Governor General Umbrella state guarantees for Budgetary Expenditure various types of loans (mortgage loans, student loans, agriculture Budgetary expenditures legally loans, small business loans) binding in the long-term (civil servants' salaries and pensions) State guarantees on private investments (such as Air Jamaica) State insurance schemes ~~ Implicit 0 Future public pensions ( as opposed 0 Default of local government, and to civil service pensions) if not public or private entity on non- A `moral' obligation of required by law. guaranteed debt and other government which obligations reflects public and 0 Social security schemes if not by law interest group pressure. (Social Safety Net) 0 Liability clean-up in entities under privatization 0 Future health care financing if not by law 0 Banking failure 0 Future recurrent cost of public 0 Environmental recovery, disaster investment relief (floods, hurricanes and riots) 84 CHAPTER 4 : REVITALIZING JAMAICA'S FINANCIAL SYSTEM I. OVERVIEW 4.1 Jamaica's growth and development are affected by the debt overhang from its enormous financial crisis. The crisis, one o f the largest in the world (in terms of GDP), was resolved relatively quickly and has led to a significant improvement in regulation and supervision of the financial system, but also to a huge increase in an already large public sector debt. This debt burdens the economy, investment, and the public sector, crowding out private sector credit and public investment, as discussed below and in the previous chapter, and thereby limits Jamaica's growth. Increasing credit to the private sector, particularly small and medium industries that are potential exporters, and home loan mortgages, will depend on a primary surplus that reduces the importance of public sector debt in the financial system, and improved credit information systems to help reduce the risk of lending, particularly to smaller borrowers, and better systems of collateral execution to protect creditors' rights and increase the incentives to repay debt promptly. Given the large share of Government debt in the financial system (in banks equal to about 45 percent of deposits), maintenance of Government solvency i s critical to maintaining the solvency of the financial system. Without continued public confidence in the Government's ability to service its debt, which backs the majority of deposits, a runcould develop on the banks andthe currency that would leadto anew crisis. 11. THE CAUSES OF JAMAICA'S FINANCIAL CRISIS' 4.2 The fundamental causes of Jamaica's financial crisis were a privatization of financial institutions without much regard to the owners' capacity to withstand crises and a liberalization of financial markets, both in the context of weak regulation and supervision, followed by a tightening of monetary policy to contain the resulting credit boom and inflation. In the late 1980s, the Government began to privatize the banks that hadbeen nationalized in the 1970s, as part of its general privatization strategy. However, the privatization was largely limited to domestic investors, who did not have large resources that could be called upon in the event of a crisis, particularly as they were subject to the same risks as the Jamaican economy. * Regarding liberalization, in the late 1980s, the Government largely reversed the interest, exchange and credit controls, and the highreserve requirements that had characterized financial sector policy earlier. 4.3 Regulation and supervision o f the financial system was weak, however. Most countries, including Jamaica, did not consider financial regulation and supervision to be a major issue in the 1970s and 1980s. After banks were nationalized, political and social ' See also the discussion inWorld Bank (2000a); World Bank (2002e); and Naranjo and Osabela (2002). Citibank and Nova Scotia Bank were already present and it is not clear that other foreign banks might have been interested. Jamaica's largest bank, National Commercial Bank (formerly Barclays International Bank which had been nationalized in 1977) was transferred to the public in stages, starting with the sale of over 40 percent of the shares in 1986. The Workers Savings and Loan Bank was privatized in 1991. objectives, rather than prudential considerations, sometimes affected Government policy toward the financial system. Regulation of non-bank entities was given even less attention. The 1992 legislation to strengthen supervision of deposit-taking institutions did not provide sufficient sanction and intervention powers to bank supervisors, even for banks that were using the liquidity facilities of the Bank of Jamaica. Instead, power to fine an institution remained with the courts and power to sanction with the Finance Minister, who sometimes granted exemptions to prudential regulations and laws. Regulationof non-bank institutions remained lax. 4.4 In this environment, a huge credit boom developed, typically a predictor of a crisis. Commercial bank assets multiplied seven times between end-1990 and end- 1995, merchant banks four times, and building societies nearly 10times (Table 4.1). The share of loans in real estate and tourism increased. Various new institutions sprung up, often linkedto old institutions under a conglomerate head, inresponse to easy entry regulations and to take advantage of regulatory arbitrage.3 Insurance companies created deposit-like instruments (lump-sum or investment policies) where 1 percent or less went to insurance andthe rest went to investments inreal estate and other highrisk assets. Table4.1 Jamaica's Financial System 1990, 1995, and 2001. - -- - -- - -- 1990 1995 2001 No. Assets YOAssets No. Assets YoAssets No.' Assets YOAssets CommercialBanks 11 17,328 62.3 11 121,325 61.1 6 239,087 68.0 Non-Banks 10,469 37.7 7 7 , 2 7 1 -38.9 112,745 32.0 Merchant Banks 21 4,527 16.3 25 17,334 8.7 13 15632 4.4 Building Societies 6 3,058 11.0 32 29,084 14.6 5 50448 14.3 Credit Unions 80 812 2.9 82 4,098 2.1 66 17279 4.9 Life InsuranceCos. 10 2,072 - 12 7.5 26,755 - 13.5 7 -29386 8.4 Total Assets 27,797 100.0 198,596 100.0 351,832 100.0 Yo of GDP 86.5 100.6 100.8 Source: Bank of Jamaica, Life Insurance Company Association Notes: aNumberof institutions refersto 1999 b2000 4.5 The credit decision and the institutions themselves were weak according to a post- crisis study by FINSAC (Financial Sector Adjustment Company Ltd., the agency created in 1997 to deal with the institutions). Lending was often highly concentrated and substantial lending to related parties occurred. Lending also demonstrated little understanding and evaluation of risk. Loan decisions were overly dependent on collateral, particularly real estate that proved to be overvalued and illiquid, rather than projected cash flows (although these too would probably have been overstated). Maturity mismatches were common. Non-performing loans were under-provisioned. These weakness ledto a crisis as GDP growth remained low and then the unsustainable boom in asset prices reversed. For example, after reserve requirements were imposed on merchant banks, which had grown in number in the 1980s, the number of building societies, which had no reserve requirements (and were only lightly supervised), increasedfrom 6 in 1990 to 32 in 1995. 86 4.6 The rise in credit was unproductive not only in terms of the inability to meet loan terms but in a macroeconomic sense. Although the rate of investment increased in the first half of the 1990s (in nominal terms), GDP growth fell sharply compared to the late 1980s (Table 4.2). Thus, inboth micro- and macro-economic terms, the allocation of the large increases incredit seems to have been unproductive. Table 4.2: Jamaica Fixed Capital Formationand Growth 1986-2001 - (percentof nominal GDP, except as noted) Average Average Average 1986-1991 1992-1996 1997-2001 TOTAL FIXED CAPITAL FORMATION - - - 22.3 28.5 27.7 CONSTRUCTION 11.0 13.3 12.2 TRANSPORT EQUIPMENT 3.6 4.3 4.5 OTHER MACHINERY & EQUIPMENT - - - 7.7 11.0 11.1 Agricultural Machinery & Equipment 0.4 0.3 0.3 Industrial Machinery & Equipment 2.5 3.6 2.7 Other Machinery & Other Capital Goods 4.9 7.1 8.1 1986-1991 1991-1996 1996-2001 Average Real GDP Growth 4.8 0.9 0.0 Source:STATIN 4.7 In the mid-l990s, the Government tightened monetary p ~ l i c ythereby reducing , ~ the high inflation that had been associated with the boom. The combination of the slow growth, poor investments, and the high real interest rates led first to illiquidity of some institutions, then to insolvency, as the weakness of their lending was exposed. Particularly hit were the insurance companies, which in turn borrowed from their related banks, thereby triggering problems in the banking sector. The interventions began in the Blaise Group, a small financial conglomerate in 1994, then the Century National Bank (where problems had actually begun in 1992, and which had received injections of liquidity equivalent to about 2 percent of GDP by 1996), and then spread across the ~ y s t e m . ~ 111. DEALING WITH THE CRISIS 4.8 Jamaica's financial sector crisis was one of the costliest in terms of GDP (Figure 4.1) worldwide, but its clean-up was one of the quickest. The high costs of the crisis Before 1995, the Government had also made some attempts to tighten monetary policy, for example between 1989 and 1991 it re-instituted credit ceilings (dropped again in 1991), raised the liquidity requirement, and discontinued payments on reserves. The tightening probably induced financial conglomerates to undertake regulatory arbitrage to avoid the tightening, for example by relying more on deposits in merchant banks and building societies and deposit-like instruments sold by insurance companies. 'The FIS (Financial Institutions Services), created in 1994, handled the problems in the first two institutions,before the creation of FINSAC. 87 reflectedthe banks' substantial use of Bank of Jamaica's unsecured overdraft facility, and the Government's 1997 blanket guarantee of institutions' liabilities, implemented by FINSAC. The Government tried to limit its liability in the first two institutions that failed but in 1997, concerned about deposit runs, it issued a blanket guarantee that was implemented by FINSAC. InMarch 2001, the Government took over the FINSAC bonds issued to the banks and the insurance companies (valued at J$ 142.7 billion or 42 percent of GDP at that time) and it i s servicing this debt.6 Note that FINSAC debt to the banks was treated as "other credit" in Bank of Jamaica statistics until 1998 and as "private credit" by the IMF until 2001, which understates the amount of public sector debt in the banking system inthose data sources untilthose years. 4.9 FINSAC's resolution of the crisis was one of the world's fastest. In July 2002, about five years after its creation, the Government closed FINSAC operations for practical purpose^.^ FINSAC took over about 172 financial institutions including banks, merchant banks, building societies, and insurance companies and their subsidiaries. In the most important cases, FINSAC merged deposits from banks, merchant bank and building society depositors, together with FINSAC bonds into Citizens/Union Bank and National Commercial Bank, then sold these banks to Royal Bank of Trinidad & Tobago Holdings and AIC Barbados (a subsidiary of AIC Canada), in 2000 and 2002 respectively. Regarding insurance companies, FINSAC transferred the deposit-like instruments into Nova Scotia and Scotia Trust, along with an equivalent amount of FINSAC securities. It has sold Life of Jamaica to Barbados Mutual Assurance and its minority stakes in Island Life, Dyoll Insurance, and few small companies, as well as its preferred shares in Victoria Mutual Building Society are being divested. Altogether FINSAC liquidated 74 companies, with liquidation o f a further 84 pending. Most assets taken over b y FINSAC have been either liquidated by FINSAC or sold; the proceeds were partially usedto reduce FINSAC debt.* IV. RESULTSOF THE CRISISRESOLUTION 4.10 The crisis and its resolution in Jamaica had a smaller effect on GDP than it did in East Asia but, unlike the Asian countries, growth did not even return to the previous, low trend three years after the crisis. Crisis resolution in Jamaica also has led to a much stronger financial system, with much better regulation and supervision, but a system that i s more concentrated and dominated by fewer banks and system that i s performing less intermediation because the assets corresponding to the deposits are now largely government debt (arisingfrom the crisis) rather than private credit. In September 2002 Governmentit also took over the FINSAC debt to the Bank of Jamaica (roughly J$31 billion) and it i s accruinginterest at marketrates on this debt. FISis handling the wind-up of the few FINSAC's assets that were not liquidated by July 2002. The Bealegroup purchased aboutJ$68 billion of non-performing loans (including accruedinterest) and is liquidating them with the Governmentretaining a share; so far about J$1.2 billion has been received by the Government. FINSAC also liquidated about J$30 billion in assets, the remaining assets are in the process of sale or have been leasedwith an option to buy. Recovery rates are obviously low and unlikely to reduce the net cost of the crisis much. 88 Figure4.1 Fiscal costs of banking crisis (as percentage of GDP) Indonesia97 South Korea 97 '1 I Cote d'Ivore 88 Japan91 I Ecuador 98 I Venezuela 94 Mexico 95 Turkey 00 I Malaysia 97 Rl Slovenia 92 Brazil 94 Philippines 83 1 Bulgana 96 Czeck Republic 89 Finland 91 Hungary91 Senegal 88 IB Norway 90 Spain 77 Paraguay 95 Colombia 82 S n Lanka 89 Malaysia 85 Sweden 91 Indonesia92 Poland92 = UxutedStates 88 Ghana 82 Turkey 82 Thailand 83 Australia 89 Turkey 94 New Zealand 87 France94 Egypt 91 $I Argentina95 Philiuuines 98 -1 II r 0 10 20 30 40 50 60 Source: World Bank estimates 89 4.11 Growth in Jamaica's growth fell much less during its crisis than was the case in East Asian countries, although Jamaica's crisis was bigger (relative to GDP) than the East Asian countries except for Indonesia (Figure4.2). However, Jamaica's post-crisis growth remained similar to, or even less than the low levels of the first half of the 1990s, until 2000, while in East Asia growth has resumed and largely recouped all of the losses. Indeed, Korea, which i s generally regarded to have cleaned-up its financial system andits corporations the most rapidly of the Asian economies, seems to be back on its original growth path. Figure 4.2 Real GDP in Selected Crisis Countries, (first crisis year =loo) 110 - 105 - 100 - 95 - 1 2 3 4 5 6 7 Year Source: InternationalFinancial Sktisfcs, IMF. 4.12 As a result of the crisis and its clean-up, Jamaica's financial system is now even more dominated by banks. The role of merchant banks and insurance companies has reduced substantially (Table 4.1).9 All intermediaries hold much more public sector debt than before the crisis and the share of private sector credit has fallen dramatically (see the next section for a discussion). The increased role of well-known international banks, and the large holdings of government debt in the system have reduced systemic risk since the crisis. International banks with a reputation to protect are likely to lend prudently and resolve any problems themselves, without the need for Government injection o f funds, as they did during the crisis. 10 Of course this depends on the Government's not attempting to tax their activities excessively, a problem that has occurred in Argentina recently. Jamaica's bank balance sheets have been cleaned up, but this i s largely the result of larger government debt holdings and, to a lesser extent, a reduction in lending except to the best clients. More Government debt means less risk of NPLs, smaller risk of runs on The reduction of the role of insurance companies and the growth of banks, particularly the international banks, partly reflects the shift of insurance companies' deposit-like liabilities to Bank of Nova Scotia and Scotia Trust. loPartly, of course, the international banks were not subject to liquidity crises because deposits shifted to them, as typically happens in systemic financial crises. 90 individual banks, and less cost of resolving any crisis inan individual bank, providing the public continues to have confidence that the government will service its debt at par.* 4.13 With fewer institutions and the corresponding increased concentration of non- mortgage lending in fewer banks, competition in lending has probably decreased (see World Bank 2000a, Annex IV). This i s particularly true since the funds available for lending to the private sector are limited by the large stock of govemment debt in the system and its large annual increases, as discussed below. 4.14 What might have been done differently to resolve the crisis? Without question the speed of the eventual clean-up b y FINSAC was excellent. Before the crisis, the weakness of regulation and supervision and the access to liquidity from the Bank of Jamaica may have contributed to the weak lending quality, the unsustainable boom, and the eventual cost of the crisis. The access to liquidity may also have permitted insiders to "loot" their banks. If weak institutions had been intervened sooner and the costs paid up- front, then the unsustainable boom probably would have been smaller, and the eventual costs of the crisis less.12 The need for prompt corrective action and acceptance of the initiallosses to avoid bigger losses later, is a lesson that has been repeated over and over incrises since the U.S. Savings and Loan crisis, but governments seem to have difficulty infacing these costs untilthey are overwhelming. 4.15 Once the Jamaican crisis became obviously large, decisions had to be made quickly with limited information. With the benefit of hindsight and the experience that has been accumulated with crises since then, it i s easier to suggest alternatives than it was at the time in the midst of large short run pressures. Nonetheless, some comments on the initialresponse to the crisis are probably worthwhile. First,it is important to understand clearly that the key issue in crisis decision-making i s the allocation of the cost o f the non- performing loans, which of course are unlikely to be measured very precisely. Generally speaking, owners of financial institutions need to be the first to bear the costs, but the amounts they have at risk (their capital) are limited. Hence, the issue soon comes down to whether depositors will bear the cost, or taxpayers and future investors (in terms of higher interest rates) will bear the cost. In Jamaica, the eventual decision was to guarantee all liabilities, despite the lack of any Government legal obligation, which meant that taxpayers and future generations would bear the cost. The Government could have refused to accept any obligation, which would have transferred all the costs to the depositors. A limited Government support of depositors and holders of deposit-like obligations of insurance companies, such as was tried in the case of the Blake group and Century National Bank (which had been allowed to continue existence b y large ''In a single bank with large government debt holdings, the loss of capital (for example because of market losses) would mean that Government intervention required little additional issue of new government debt to comply with the guarantee. O f course, the Government might need to provide cash to cover possible deposit outflows, but it should be able to do this without greatly disturbing monetary policy provided it can access marketsand the run is to other banks and not on the currency, i.e. confidence in the Government and the currency remains. This analysis suggests that runs on individual banks are probably less likely than previously, though some of the foreign banks experience runs in the case of problems in their home countries. O f course, the key issue is continued confidence in the Government and the currency. '*Legal and regulatory constraints made prompt intervention difficult; these constraints have now been eased, as discussedbelow. 91 borrowings from the Bank of Jamaica), would have reduced the cost o f the crisis to the taxpayers compared to the blanket guarantee. However, concerns about capital flight and depreciation, perhaps excessive, led to the blanket guarantee. An alternative to the blanket guarantee would have been another approach to force depositors to bear some of the cost-the forced conversion of, say, time deposits into long-term, marketable instrumentsbearing below-market interest rates. The banks could have been permitted to do this, in effect making their depositors equity investors in their portfolios, or the Government could have issued such bonds, which would have lowered the cost compared to the actual approach. Either way, the depositors would have borne some of the cost, but would have had access to (a reduced amount of) their deposits if they needed liquidity, through the market for the instruments. Whether this approach would have been legally possible inJamaica i s not clear, but it i s not clear that this would have been more difficult legally than the blanket guarantee, though certainly less attractive politically. Inaddition, complicated as it might have been, some reduction in the cost might have been made by crossing deposits with defaulting borrowers, given the large amount of connected lending that seems to have occurred. This crossing of deposits and bad loans might have been facilitated by the substitution of marketable instruments for bonds. V. THE DEBT OVERHANGAND ITS EFFECTS 4.16 Jamaican public sector debt, already large before the crisis i s now almost 150 percent of GDP; domestic debt i s about 90 percent of GDP, largely reflecting the replacement of financial institutions' loans by government debt. The resulting 45 percent ratio of Jamaican Government debt to total bank deposits i s one of the highest in the world. This debt reduces the risk of the banking system, as long as confidence is maintained in the government's capacity to service the debt at par, but the stock and the flow of debt crowds out new lending to the private sector, particularly to SME and riskier clients. This has led to pressures to resort to government directed credit with all its risks. A large primary surplus, and better information, particularly on smaller borrowers, i s needed to limit the flow of new debt and increase the availability and reduce the cost of credit to the private sector. 4.17 Jamaican public sector credit typically has represented about 50 percent of commercial bank deposits, about 36 percent o f assets, and about 25 percent of GDP inthe last few years. In contrast, private sector credit represents only about 25 percent of commercial bank deposits, 18 percent of assets, and 10-12 percent of GDP (Figure 4.3). These recent figures are roughly a reversal of the 1994-1995 figures, when private credit represented about 20 percent of GDP and public sector credit less than 5 percent. 4.18 A similar story of increased government debt, reduced private credit is true for merchant bank and building societies. In the merchant banks, loans and advances have fallen by 50 percent in J$, equivalent to a drop from 3 percent of GDP in 1994 to less than 1 percent of assets in 2001. The building societies' new mortgages in 2001 were only about 10 percent larger in nominal terms than in 1996; they fell from 0.3 percent o f GDP to 0.1 percent of GDP. Meanwhile their stock of Government securities rose 75 percent in nominal terms. With the decline in mortgages from banks and building 92 societies, the Government has become the main provider of housing finance since the mid-1990s. Figure 4.3 Jamaica: Bank Credit to the Public and Private Sectors 1994-2002,percentof GDP 35 7 - 35 30 - --30 25 - --25 2 0 - /- L a --20 15 --15 10 - --10 5 - 1 T 5 Note:1994 Public Sector Credit estimatedfor 19981997 1995 1996 Source: Bank of Jamaica; IFS, IMF.2000 1998 1999 2001 Sept 2002 4.19 The Jamaican ratio of net Government debt to bank deposits (45 percent in June 2003) is one of the highest in the world (Table 4.3). In addition, public enterprise debt represents another 10percent of deposits. Like Jamaica, most of the countries that have a large percentage of Government debt to GDP have experienced financial crises. Inthese countries, restoration of financial sector solvency after the crisis, by replacing private non-performing loans with Government debt, means financial solvency depends on the ability of the Government to service its debt or to roll it over. Confidence inthe financial system thus depends on the public's confidence in the Government's debt servicing capacity. 4.20 Casual observation and some cross country evidence from some 86 developing and industrial countries suggest a negative relationship between total public sector debt (as a percentage of GDP) and GDP growth (Figure 4.4). This empirical result is something of a replication of other work that shows a positive empirical relationship between growth and the size of credit to the private sector (relative to GDP) across c~untries.'~Clearly, many of the countries with large public sector debts have had financial crises, and part of the explanation for the negative correlation between public sector debt and growth may be the lengthy work-out of the crisis and an associated deterioration of the investment climate. Financial institutions are no doubt cautious in making new loans to individuals and firms that had large non-performing debts, and in some cases still have them to asset management companies (an issue that does not apply to Jamaica). The negative relationship between public sector debt and GDP i s relevant to Jamaica for three reasons, however. l3Levineand Levos (1988). 93 Table 4.3 GovernmentNet Credit StocWDeposits,Banks, 2000 (percent) Korea -3.6 Philippines 22.7 Chile -3.1 Hungary 23.0 Thailand 1.4 Pakistan 24.6 Malaysia 2.3 Morocco 26.5 Peru 3.2 Argentina 30.8 S. Africa 4.9 India 34.6 Czech Rep. 4.9 Russia 35.3 China 6.0 Jamaica (June 2003) 45.1 EgYPt 7.8 Brazil 43.3 Venezuela 8.2 Mexico 48.8 Bangladesh 10.9 Algeria 50.6 Poland 14.8 Indonesia 56.3 Colombia 16.4 Turkey 64.7 Average 22.3 Source: International Financial Statistics, IMF. Net Credit Stock = Claims on Gov. - Gov. Deposits Deposits= Demand t Time Deposits 4.21 First,the large stock of public debt mostly represents the claims on the future tax receipts and borrowing power of the government, not any addition to the country's productive capacity. The public sector debt did replace non-performing loans to the private sector, and the uses to which these loans were originally put still exist-in this sense there i s some overestimate of the impact of the crisis and public debt on the stock of private credit. But these loans were obviously not productive-that is the mainreason for the crisis. As discussed above, the macroeconomic returns for Jamaica of the.rise in credit and investment rates, was negative. And, from the microeconomic standpoint, the recovery rates on the non-performing loans (including repayments made by the borrowers even if the loans were not productive) and the collateral have been less than 20 percent. So, on balance, there has been a rise inpublic sector credit, and a displacement of private credit, which has its own effects on future growth. 4.22 Second, in Jamaica, some bankers have expressed the view that the high rates on government debt and deposits may have reduced the relative incentive for potential entrepreneurs and may have even turned some of them into rentiers. With fewer entrepreneurs, there i s likely to be less growth. 4.23 Third, there is the standard problem of crowding out of private investment (see Chapter 3). Jamaica's public sector debt overhang (and the other countries with a large public sector debt overhang) must be refinanced, along with the interest on it. This has a continued negative impact on growth by displacing potentially new private borrowing. Unlikethe repayments of private sector loans, which, if they hadbeen performing, would have been relent to new borrowers, or to the same borrowers for new uses, the public debt 94 i s simply rolled over along with much of its interest cost, depending on the size of the primary surplus of the government. The refinancing of the interest absorbs much of the nominal increases indeposits. Thus, much of the additional deposits simply go to finance the stock of debt and its interest, not more productive investment. Correspondingly, private sector lending by Jamaica's financial sector has barely begun to return to its previous relationship with GDP.l4 Figure 4.4 GDP Growth and Total Debt (%GDP) (Five Yr. Averages, 97-01) 10 9 1 y = -0.018Xi 4.2874 R = 0.129 1 1 5 - 6 :****.** ** * * e . GDP ** 6 Growth4 * - A * 3 *** * ** *** 2 * + I 0 25 50 75 100 125 150 175 200 225 -1 -0 -2 j I -5 Total Debt (%GDP) Source: International Financial Statistics, IMF. 4.24 Jamaican public sector debt probably crowds-out private sector borrowing through both the interest rate and credit rationing based on risk. Public sector debt i s naturally attractive to banks-it carries no risk of non-performance, and no capital requirement (the risk weight i s zero)-relative to private sector debt. But this i s a relative attractiveness that simply determines the spread between credits to the public sector and credits to the private sector. The level of (real) interest rates i s determined first by the needs of the public sector to finance its amortizations, its interest costs, and its annual deficit. If a lot of public sector debt service needs to be rolled-over and a primarydeficit financed, then the (real) interest rate i s higher than if a smaller amount i s needed.15 The deposit rate may also be driven up in these circumstances. A higher rate on public sector debt and higher deposit rates in turn mean a correspondingly higher rate for the private l4 Interestingly,in Jamaica the rate of (nominal) investment has not declined much, despite the squeeze on privatecredit. This suggeststhat more investmentis beingself-financed, or financed offshorethan earlier. l5 The Government has been running a primary surplus in terms of current revenue and current spending, but even after deducting the primary surplus, the interest costs have often been similar to or even larger, as a percentage of GDP, than the nominal GDP growth rate. Moreover, the Government has also taken over the FINSACdebt, so the ratio of debt to GDPhas increasedcomparedto 1998/99. 95 sector, crowding-out enough private borrowers to reduce the total of inelastic public demands for credit and rivate demands for credit to what the financial system can supply by mobilizing deposits. p6 Higher rates also tend to drive private borrowers off-shore and to borrow inforeign exchange locally to reduce their costs-interest rates and spreads are both lower inforeign exchange than inJamaican d01lars.l~Currently short- term offshore borrowings (largely private) are a much higher percentage of GDP (12 percent) than in the past, and these of course go mainly to the least risky, best known clients. 4.25 O f course, Jamaica's crisis and the lack of recovery may also widen the spread between public sector debt and private sector debt, or simply screen out potentially riskier borrowers. After the crisis, banks and other lenders naturally have been concerned over potential borrowers' repayments. Hence, the banks probably not only charged higher spreads over government debt to the same borrowers, but reduced their lending to riskier borrowers (and they have less funds to lend because existing borrowers are not repaying, adding to this effect). The result tends to be a rise in the average measured spread (for a group of less risky borrowers) and an exclusion of credit to riskier borrowers, for example small and medium borrowers. 18 19 4.26 Jamaica's interest rates over the 1990s seem to reflect these considerations. The crisis, tight money, concerns about devaluation, and the need to cover government deficits were associated with higher real average lending rates by the banks in the early part of the 1990s (Figure 4.5). After the crisis, real rates (and spreads over deposit rates) widened further and presumably only the best borrowers were able to raise money locally. With the stabilization of the exchange rate, some private borrowers even went offshore for bank loans. Gradually, however, average lending rates have fallen and spreads have narrowed back to their pre-crisis levels. However, the smaller amount of 16 The public sector can reduce these impacts on the domestic financial system, and reduce its borrowing costs, by borrowing offshore, as the Government of Jamaica has done. However, this strategy is limited by the country lending limits in private markets and the multilateral institutions and involves a currency risk. Multilateral firms, such as those in bauxite and telecommunications typically raise much of their funding offshore. To the extent that such firms have become more prevalent in Jamaica, the demands upon the local financial market for private sector credit may be less than in the past. The tourism industry i s basically a franchise operation for local investors, and they continue to depend heavily on the local financial system. Bank loans for tourism, though not keeping up with the growth of deposits, have risen 25 percent since 1995, helping to finance the increase in capacity by large hotels. However, casual observation suggests that smaller hotels have lost access to local finance and never had offshore finance. This result assumes the increase in the average spread to the remaining borrowers is greater than the s read that prevailed for the riskier borrowers that are excluded. The Bank of Jamaica's Analysis of Commercial Banks' Loans and Advances indicate that total loans have increased roughly 50 percent since 1994. Within this total, loans to agriculture, manufacturing and the professions are now less in J$ than they were in 1994, and loans for construction are down by nearly half. Loans for tourism and personal loans have more than doubled, and loans for transport, storage and communication have increased 50 percent. Loans to non-government public entities are five times larger, and loans to the central government (not counting treasury bills or LRS) are 250 percent of their 1994 levels. Of course, these shifts in the distribution of loans probably reflect not only crowding out, but the growth of the real economy. Credit cannot substitute for poor real prospects. The sharp growth of personal loans, most of which occurred in two bursts, 1994-1996 and 2000-2001, probably reflects the increased emphasis on consumer banking by banks all over the world, a type of lending that has proved to have surprisingly low risk and high returns. In some cases, small and medium firms have used personal loans and credit card debt for funding. 96 private sector credit, relative to GDP, suggests that the composition o f the private sector borrowers may be less risky, on average, than in the past. Longer-term private offshore borrowing has now died out, although short-term borrowing offshore has risen to about 12percent of GDP compared to less than 10percent inthe early 1990s. 4.27 The lack of private credit thus reflects crowding-out by the overhang of the debt crisis. Despite government primary surpluses and Government offshore borrowing to take advantage of low international rates and reduce the pressure o f the debt overhang on the domestic economy, the stock of private credit in the banks currently i s only about 12 percent of GDP. Foreign short-term borrowing has provided some respite for some borrowers and in fact i s now more important, relative to GDP, than credit from the banking system. But both sources of funds are limited to the best customers. 4.28 While credit alone cannot be a leader of a private sector recovery - it makes little sense to lend to companies with poor repayment prospects-it i s still natural to ask what could be done to increase the availability and quality o f credit to the private sector?20 First, it seems likely that as long as the public sector debt i s large and growing, then it will continue to crowd out private credit, especially for small firms. Large firms still have access and may be able to borrow abroad. Hence, a basic issue i s reducing the growth of public sector debt, both of the government and other public entities, whose debt has increased dramatically. 4.29 Second, credit registries can provide better information to allow financial intermediaries to distinguish between borrowers who are likely to repay their debts and those that are likely to default at the slightest downturn of their prospects, they also can improve access to credit. Credit registries that allow financial intermediaries to see even small borrowers' credit histories are a way to improve intermediaries' ability to distinguishbetween good borrowers and badborrowers. They also provide incentives for borrowers to repay, to maintain a good credit record. Small borrowers, by repaying, can develop the intangible asset of a good credit record. Credit registries can also be used as collateral registries to help lenders see what collateral has been pledged. Finally, credit registries are also a way of increasing competition in lending, which i s one reason why lenders are so reluctant to contribute information on their good borrowers to such an institution, andwhy Government often have to promote their formation. 4.30 Third, improve collateral execution, perhaps by creating special courts for debt disputes and bankruptcy. Surveys show dissatisfaction with the courts' performance on commercial issues. *'Monetary policy of course can stimulate private investment, but Jamaica's capacity for monetary policy i s limited by its openness. Moreover, monetary policy's main impacts often come on construction and housingprojects and, as discussed in Chapter 11, a stock of underutilized buildings still exists. 97 Figure4.5 Commercial Banks Loan Ratesand Inflation, end June 10 - 1993 1994 1995 1996 1997 1998 1999 2000 2001 Source Bank of Jamaica, IFS, IMF 4.31 The Jamaican Government also has tried to channel credit to the private sector through Government financial institutions. Public sector institutions have become the main financers of housing- while down somewhat compared to 1995-1997, public sector financed housing starts and completions are more than twice as high as in 1994. In addition, the National Investment Bank of Jamaica and the Jamaica Development Bank have provided increased direct and second-tier credits to the private sector, partly funded by the reduction inreserve requirements of the banks. To some extent, all these loans can be considered as "pump priming"- providing credit when the private financial institutions may have overreacted to the crisis. However, these institutions have had poor recovery records on their direct lending, which may be related to concerns that have been expressed in Parliament regarding the use of credits for political purposes. To the extent that the direct lending of these institutions i s not repaid, the credits must be considered a poor allocation of resources and the government will have to issue new debt to cover the institutions obligations, further crowding-out private sector credit of the banks. The indirect lending of these two institutions, through the banks, probably has less risk, but the ceilings on the interest rates for loans financed by this facility mean that banks find these funds unattractive, except to finance loans to very low-risk borrowers. VI. THE POST-CRISIS IMPROVEMENT IN FINANCIAL SECTOR REGULATION,SUPERVISIONAND THE SOLVENCYISSUE 4.32 The Government has improved financial sector regulation and supervision greatly since the crisis, a further contribution to reducing systemic risk, arising from the financial system. Inthe banking sector, minimumcapital requirements were raised to 10 percent of risk weighted capital (1999); recognition of non-performing loans was tightened to 3 months (best practices) from 6 months; stronger guidelines were issued for provisioning, loan renegotiation, suspension of accrued interest on non-performing loans and loan write-offs; and limits on connected lending and concentration of lending have been 98 introduced. In 2001, the Bank of Jamaica carried out an assessment of its compliance with the Basel Core Principles, led by the IMF, which concluded that supervision was fully compliant with 11 principles, largely compliant with 8, materially non-compliant with 5 and non-compliant with 1. To address the areas of weakness, the Bank of Jamaica has drafted prudential regulations on county risk (although Jamaican banks are not currently exposed to country risk), marketrisk, and consolidated supervision. 4.33 The Bank of Jamaica has received increased powers of bank intervention and independence of supervision. It can now impose penalties for technical breaches of sanctions and has the power to temporarily assume management of deposit-taking institutions. However, the Finance Minister retains the power to approve and transfer licenses (with a recommendation from the Bank of Jamaica), revoke licenses, and bar persons from participation inbank management. The Bank of Jamaica has also continued to strengthen its "ladder of enforcement", which includes recognition of problems at an early stage, prompt corrective actions, steps to minimize systemic effects, and a list of the sanctions that will be imposed by Bank of Jamaica. 4.34 To strengthen consolidated supervision, the Bank of Jamaica has since received powers to carry out consolidated supervision that includes non-bank institutions in bankinggroups. It has also signed an M O U with the Financial Services Commission that supervises securities and insurance, and received legal sanction for sharing information with supervisors. It also participatedin the creation of the Financial Regulatory Council, a coordinating body for financial regulation and exchange of information, chaired by the Governor of the Bank of Jamaica. 4.35 Regarding non-bank intermediaries, the Government has enacted an Insurance Law to serve as the basis for regulation and supervision inthe sector. The Government in 2001 also created a Financial Services Commission to regulate and supervise securities, insurance and pensions. The Bank of Jamaica i s also developing a framework for regulation and supervision of credit unions. Improvements in the regulation of pensions are also being considered, a potentially important issue given the aging of the Jamaican population. 4.36 Jamaica's strengthening of bank regulation and supervision has corrected many o f the problems prior to the crisis and identified in the assessment of the Basel Core Principles. However, many of these changes that have been implemented address issues that will only become important as the overhang of the crisis decreases much more. For example, risk-weighted capital requirements, income recognition and provisioning of loans, and risk management of lending are not major issues given the large share of public sector debt in the system. Work on assessing market risk i s desirable, given the large share of government debt in assets, but the Bank of Jamaica must carefully tread a narrow path between allowing institutions to take reasonable risks and outlining what i s prudent and imposing costs on imprudent behavior (for example in terms of capital). Consolidated supervision i s also not a big issue currently, given the reduced role of non- bank intermediaries and the rise in their holdings of government debt and foreign assets, though i t could become one in the future. O f course, consolidation of debtors' accounts 99 within the banks and a supervisory assessment of the degree to which a bank's risk management considers this consolidation are always important. 4.37 Two issues-cross-border supervision and harmonization of laws and regulation-could be important in the short run. Given the importance of foreign ownership in banking and insurance, the sharing of information with foreign supervisors i s important and will need to be pursued. In a number of countries, problems faced by foreign banks in their home countries have turned into problems for offshore operations of these banks. Harmonization of laws and regulations within Jamaica also could be an issue, given the numerous changes in banking laws and regulations that have occurred since the crisis. The Government i s considering such an omnibus law, and the Bank of Jamaica has made proposals for a draft. As noted above, pension regulation i s also becoming an issue. 4.38 Post-crisis, the solvency of Jamaica's financial system has become heavily dependent on the public sector's solvency, and less on the private sector's servicing of its debt that i s the usual focus of supervision. The full bail-out of the depositors after the crisis, by replacement of all bad private debt with Government debt, has left total Government debt at about 45 percent of deposits. Hence, Government's capacity to either rollover its debt or service it out of the budget i s critical to the banks' capacity to cover the interest costs of their deposits, and will depend on improving the ratio of the Government's primary surplus to its debt service. 100 CHAPTER 5: IMPROVINGEDUCATIONOUTCOMES I. INTRODUCTION 5.1 Jamaica's Government spends six percent of its GDP on education, and real expenditure on education has doubled in the last ten years. Enrollment has expanded remarkably, and was near universal for 6-14 year olds as early as 1989, and 95 percent for 12-14 year olds from the poorest quintile. Yet, education outcomes leave much to be desired-- about 30-40 percent of grade 6 leavers are functionally illiterate. Only 30 percent of those who appear pass the Caribbean CXC mathematics examination in grade 11, lower than most Caribbean countries. Jamaican-educated workers receive amongst the lowest returns in the U S labor market. Poor education outcomes may be one factor limiting productivity gains in Jamaica, both in absolute terms and also as compared to other Latin American countries (see Chapter 2). Cross-country evidence shows that higher quality education makes workers more productive, increases returns to education and creates incentives for more private investment ineducation. 5.2 Much of the problem stems from poverty. Poor students get tracked into lower quality schools, have higher absenteeism, face a more difficult home environment, see lower enrollment after age 14 (owing to lack o f seats in schools) and higher dropouts, and end up far less educated. All this creates a vicious cycle of youth at risk, especially males, and unemployment and poverty. Tackling these problems would involve a coordinated approach that would address issues of school quality of below-average schools, increase school space after grade 9, and pay special attention to those falling behind and reading below grade level. 5.3 The next section discusses the international evidence on private and social returns to education, and suggests that quality o f education matters as much as the numbers. Section I11discusses the expansion in education coverage in Jamaica, but suggests that it came at the cost of quality. Section IV presents evidence on social returns to education in Jamaica, and makes a case that even social returns are positive. Section V discusses poverty, enrollment, student achievement, and the quality of schools, and the linkages therein. Section V I shows that rising expenditures do not guarantee outcomes, and also demonstrates the unequal distribution of expenditures in tertiary education. Section VI1 concludes with some policy options to improve the effectiveness of education, building on the 2001 White Paper of the Government. It i s worth noting here that international experience shows that improving education outcomes i s likely to be a slow and difficult process, and i s rendered more complex in Jamaica b y the strong linkages of education with poverty and social factors. ' World Bank(2003), Chapter 4. 11. THE INTERNATIONAL EVIDENCE ON PRIVATE AND SOCIAL RETURNSTO EDUCATION 5.4 Protagonists of the human capital approach hold that education enhances skills that improve human productivity and, thereby, economic growth. While there i s strong empirical evidence on the positive private rates of return to investment in education, the micro-macro link between education and economic growth remains contentious.2 5.5 Using data from around the world, Psacharapoulos (1994) and Psacharapoulos and Patrinos (2002) find that private returns are higher than social returns only when the social costs (public subsidies for education), but not social benefits, are accounted for. Overall, the average return to an additional year of schooling i s 10 percent. Over the last 12 years, the average education return declined by 0.6 percentage points, owing to the increase inthe supply of educated labor outstripping the demand. Private returns increase with higher levels of education and are higher for those working in the public sector than the private sector. Social returns are higher in primary than in secondary education, which, in turn, are higher than those in tertiary education. Social returns are higher for women than for men, and lower for countries with higher levels of GDP per capita. 5.6 Inthe same vein, Tope1(1999) argues that the key is not whether schooling raises aggregate output but whether the social returns to human capital formation exceed private returns. The arguments for the social returns being lower than private returns include: (i) education signals innate ability and does not enhance productivity; and (ii) sector public over-hiring of educated workers distorts the labor market. The arguments to the contrary include the following: (i) worker productivity depends on co-workers' education as much as own schooling (particularly in team-based production); (ii)schooling promotes technology adoption and technological innovation; (iii)educated women have lower fertility rates, and their children have better health and education outcomes, thereby leading to inter-generational mobility; and (iv) schooling may reduce crime and other anti-social behavior (Jamison, 2002). In other words, high social benefits are likely to have a positive impact on economic growth, directly or indirectly. 5.7 Using cross-country data, Pritchett (2000), however, finds no relationship between increases in human capital attributable to rising educational attainment of the work force and the rate of growth of output per ~ o r k e r .He attributes this finding to ~ three possible reasons: (i) institutional/governance environment that encourages perverse rent seeking behavior of educated people; (ii)rapid decline of marginal returns to education as the supply of educated labor outstripped demand; and (iii) low educational quality that creates no human capital. However, some recent work by Temple (1999) finds that increases ineducational attainment are correlated with growth, once outliers in * The cross-country empirical investigations typically use either the level or change in the level of education as the independent variable to explain the growth of economic output. The summary of the debate draws from Jamison's (2002) literature review. The findings of these cross-national data are the average results, derived from imposing a constant coefficient; in practice, the development impact of education on growth will vary widely across countries. 102 the data are removed. Barro (2001) also finds that the amount of schooling has a positive and statistically significant relationship with growth. 5.8 That quality matters should not come as a surprise. Regressing 1960-1990growth on a standard set of factors (including schooling quantity), plus a new measure of educational quality (scores from international mathematics and science tests), Hanushek and Kimko (2000) find quality to be a positive and statistically significant determinant of economic growth. This i s corroborated b y Barro (2001), who finds a large, positive impact of educational quality on growth. These findings also appear to affirm at least Pritchett's thirdpoint on the importance of the quality of education. 5.9 This brief review highlightsthe complexity of the relationship between education and growth. It i s already apparent, however, that the quality of education matters as much as the number of people who receive education. Also, even if the relationship between education and growth were still open to question, the long-term social benefits of quality education would appear to be significant. 111. PROGRESSINEDUCATIONCOVERAGE, BUT QUALITY SUFFERED 5.10 As part of the nation-building process, Jamaica's education plan in the 1960s emphasized making primary education accessible to all and expanding post-primary opportunity, and this was furthered by the socialist-oriented People's National Party (PNP), which came into power in 1972. Primary education was made free in public schools in 1973. In addition to building new schools, public financing (subvention) was extended to schools previously operated b y private groups and missionaries. 5.11 Due to this early emphasis on primary education for all, Jamaica attained near- universal primary enrollment by the early 1980s, much sooner than most developing countries or countries of similar income levels. This i s remarkable considering the rapid growth of the primary school-going population from the 1960s through the end of the 1980s. However, enrollment expansion came at the cost of quality (see below and sections V and VI). Across schools, there was wide variation in size, student-teacher ratios, teacher qualifications, availability of teaching and learning materials, and the conditions of school buildings. Many schools were put on double shifts. In order to make places available to an ever-increasing number of children, automatic promotion became the norm, which, unfortunately, has led to many children moving through the system without learning the requisite skills. 5.12 The coverage of secondary education remained limited until the 1980s, necessitating rationing o f secondary school places through a national examination held after completion of primary education. The Common Entrance Examination was introduced in 1953 to select the most promising students for the academically oriented secondary schools, while the less prepared students were tracked into practical or pre- 103 vocational school^.^ Over time, a multiple track system came to be established to cater to students of different abilities. 5.13 In spite of the shortcomings of the system, the sustained focus of policy on education resulted inpractically universal enrollment of all children between 6 and 14 by 1989; as many as 95 percent of adolescents between 12 and 14 from the poorest quintile enrolled in school (PIOJ, 1990).5 The 1990s saw enrollment expansion in early childhood education, senior secondary education, and tertiary education. This was facilitated b y a decline in the 1990s of about 6 percent in the school-going population at the primary level, and 4 percent at the secondary level (MOEYC education statistics, various years). 5.14 B y 2000, gross enrollment had reached 93.5 percent in early childhood education, practically universal inprimary and lower secondary education, 88 percent in upper cycle secondary education (grades 10-1l), and about 14.5 percent intertiary education. Gender parity i s achieved at all levels before senior secondary education. The formal education system serves about 756,518 students at all levels, or about 30 percent of the total population. About 5 percent of the primary school students and 6 percent of secondary school students enroll inprivate schools. 5.15 These remarkable accomplishments reflect both a successful focus o f education policy and a strong household demand for education. Government commitment i s reflected in high and rising public spending-public expenditure on education rose from 3.4% of GDP in 1992/93 to 6.8% in 1997/98 and 6.1% in 2001/02 (average L A C public spending i s about 4.5 percent of GDP). Moreover, the increase in public expenditure came during the `lost' decade of the 1990s, when a stagnant economy witnessed many competing demands for public funding. Outside o f education, training accounts for another 0.5 percent of GDP. Also, the vocational training complex for out of school youths, HEART/NTA, i s financed by a 3 percent payroll tax (see also Chapter 3). In Inpre-independence days, missionaries ran secondary schools, later known as the Traditional High Schools. The government extended public financing to these schools, paying teacher salaries, thereby absorbing them into the public system. Since these schools were academically oriented and highly selective, other types of schools were introduced for less academically inclined students. Comprehensive Schools, providing five years of secondary education with a mixed curriculum, were established and expanded, followed by New Secondary Schools, which had a pre-vocational orientation. There were also the All-Age schools, established in the early 19thcentury by missionaries and private charities for children of slaves, offering instruction for children of mixed age groups, and whose scope gradually expanded to include nine years of education to rural children. In the 1990s, the Ministry of Education, Youth and Culture decided to reduce educational stratification by upgrading a large number of All-Age schools to Primary and Junior High schools, eliminating New Secondary Schools and their curriculum,as a distinctive category and merging them with Comprehensive Highs, and finally, renaming Comprehensive Highs and Traditional Highs as High schools. In2001, there were five types of schools, down from seven earlier: (i) All-Age Schools, mostly located 363 in rural areas, offering grades 1-9; (ii)90 Primary and Junior High Schools, upgraded from All-Age Schools, also offering Grades 1-9; (iii)134 High Schools (comprising 59 Traditional Highs and 75 former Comprehensive Highs), offering Grades 7 to 10 or 13; (iv) 14 Technical High Schools; and (v) 3 AgriculturaVVocational Highs. The first Survey of Living Conditions was conducted in 1989, which has made possible an assessment of enrollment by consumption quintile. 104 addition, household spending on education amounts to about 5.5 percent of total household spending. Of this education expenditure, about 19 percent i s on extra lessons, 35 percent for lunch, 21 percent for transport. 5.16 Quality indicators(see also sections V and VI). Comparing returns to education for immigrants of different countries in a single host country could provide some indication of the quality of education in the `sending' country.6 Bratsberg and Terrell (2002) estimate country-specific immigrants' returns to education in the US labor market. Not being affected by home country labor market conditions, the rates of return provide some pointers to home country educational q ~ a l i t y . Table 5.1 regroups the Bratsberg ~ and Terrell estimates of returns to education in the U S A by country of birth of male immigrants between the ages of 15 and 64. 5.17 The mean return to education in the U S for 67 countries i s about 4 percent per year for each additional year of schooling in 1980, rising to 5 percent in 1990. The returns to education of male immigrants educated in Jamaica averaged 2.5 percent per year, rising to 3.5 percent in 1990. The Jamaican male workers' returns are marginally below the returns to Trinidad and Tobago workers (2.7 percent in 1980 and 3.75 percent in 1990). The Jamaican returns are well below the median, although there i s improvement between 1980 and 1990. In 1980, Jamaican workers' returns, at 63 percent of the overall mean, exceed only 5 of 66 other countries in the sample. In 1990, the return exceeds 13 of the other 66 countries, rising to 73 percent of the mean. It i s reasonable to infer that the rising returns over the decade of the 1980s reflect some improvement in the quality of Jamaica's education system, notwithstanding the expansion of educational opportunity in the second half of the 20th century. However, the very large number o f countries with higher returns also indicates that the quality of Jamaica's educational system has a long way to go before it catches up even with those of much poorer countries (see Table 5.1). 5.18 Another indicator of quality derives from employers' perception o f school quality in2000 (Figure 5.1).* While this indicator is not as robust as the previous one, since it is based on perceptions, and is also based on within-country data, and so cannot abstract from cross-country differences in judging standards, it does show a very close correspondence with the findings o f Bratsberg and Terrell (2002). Employers rated highly the school quality of OECD countries, but the Central American schools obtained very low scores. The perceived school quality of Trinidad and Tobago, Uruguay and East Asia are lower than OECD's, but high relative to other countries. Jamaica i s lower but above mid range, which may indicate that domestic rating of Jamaica's schools is somewhat better than the international perception. However, the average returns for each country will be affected by the distribution of occupations for the migrants of different countries, and these are unlikely to be the same across countries. Their estimates of returns are negatively correlated with those reported by Psacharapoulos (1994), which they attribute to the labor supply conditions in determining education returns in home countries. * The employers' survey was conducted in 2000, so the rating covers the employees educated in the 1990s whereas the US censuses of 1980 and 1990 obviously do not include workers educated in the 1990s. 105 Table 5.1: Returnsto education of male immigrantsin USA by country of birth Central America Costa Rica ,0296 ,0036 207 .0377 ,0032 295 Guatemala ,0200 ,0026 566 .0214 .0016 1,922 Honduras ,0254 ,0034 283 ,0234 ,0024 701 South America Argentina ,0436 .0018 704 ,0506 .0016 875 Brazil ,0496 ,0028 246 ,0417 ,0019 659 Chile ,0406 ,0023 352 ,0438 .0021 514 Colombia .0283 .0015 1,287 .0332 ,0012 2,269 Ecuador .0220 ,0020 783 .0277 .0017 1.120 Mean (67 countries) I,0389 I ,0119 I 77,198 I,0492 I.0156 I117,774 Source: Bratsberg and Terrell (2002), Table 1, pp. 180-181, 106 Figure5.1:School Quality According to Employers' Appraisal . Trinidad&Tobago UWwY East Asia & PacificHighIncomeOECD *Jamaica ElSalvador Brazil Mexico< Argentina CostaRica Colombia Venezuela Pe;t LAC ~ o l i v i a t * Paraguay Guatemala Honduras # Ecuador ' 0 1 1 I I I I I 1 I 0 1 2 3 4 5 6 7 Public school auality Source: Global CompetitivenessReport 2001-2002, World EconomicForum(1= Lags far behindmost other countries, 7 = amongthe best inthe world) 5.19 Returns to education have also been calculated within Jamaica. In keeping with the literature, private returns to education were found to be positive. An analysis of the Jamaican Labor Force Survey of 1996 found that the private returns to an additional year of primary education were 5 percent, those for secondary education 3.3 percent, those for technical and vocational training 1.1percent, and those for tertiary education 8.4 percent (World Bank, 1999). This is below the 10 percent return worldwide observed by Psacharapoulos and Patrinos (2002). However, given the economic downturn Jamaica experienced in the second half of the 1990s, it i s not surprising that economic returns to education are low. At the same time, the relatively low returns to pre-tertiary education could reflect low quality. In addition to higher quality', the reasonably high returns to tertiary education indicate that the demand for higher levels of skills i s still strong. IV. SOCIAL RETURNS TO EDUCATION 5.20 Cross-country regressions show that education and growth are positively and significantly related in a large sample of countries. On average, a 10% increase in secondary enrollment i s associated with a 0.17% change in the annual growth rate of income per capita. In the case o f Jamaica, secondary enrollment increased by around 12.4% between the 1980s and the 1990s, and a 0.21% increase in growth of income per capita i s attributedto this (Loayza et al, 2002). 5.21 However, these coefficients for education could be biased upward for Jamaica, which has much higher migration rates than most countries (the highest in the Bratsberg For more details on tertiary education in Jamaica, see Kim (2003) and the forthcoming World Bank report on Tertiary Education in the Caribbean. 107 and Terrell (2002) sample). As we have seen in Chapter 2, highly educated people tend to migrate from Jamaica, with the most popular destinations being the United Kingdom (UK),Canada, USA and other Caricom countries. The very large scale of migration may conceivably have affected growth, by taking away potential entrepreneurs and business leaders. Thus, even if enrollment in secondary school increases, many of those enrolled are not available to the country at the precise time when they could contribute to economic growth. In other words, the effect on growth of increases in education may be lower than average incountries where the migration of educated workers i s significant. 5.22 Social benefits. What i s the evidence that education has yielded social benefits in Jamaica over and above the private rates of return? One obvious benefit has been the reduction in fertility." The general fertility rate, the number of live births per 1000 women in the reproductive age group, declined from 100 in 1991 to 76 in 2002 (2002 ESSJ). This demographic transition has resulted in a decline in the school-age population, relieving pressure in the classroom, makingpossible lower student-to-teacher ratios, and freeing up resources to improve quality. Smaller families also allow parents to devote more resources and attention to their children, thereby bringingabout a qualitative improvement in both family life and education attainment. These are undeniable social benefits of education. 5.23 As for the relationship between education and crime reduction, the issue is complex. On the one hand, micro-level data shows that positive school experiences appear to reduce the chances of risky/criminal behavior, even after the child has passed out of school. Sample data has been collected on youth behavior and its causes, in schools in nine CARICOM countries including Jamaica.'' It i s found that boys and girls who feel 'connectedness' to a school-through a teacher or by working hard-have a less than 10 percent probability of engaging in risky behavior. For those who do not feel any connectedness, their participation in drugs was 55 percent (boys) and 30 percent (girls), violence (70 percent for both boys and girls), and so on. The positive role of the school system in reducing risky behavior i s indicated by the data showing that 88% of the sample of students felt connected to a teacher. This connectedness was found to be reinforced by positive home and community support. The interviewed youth said that their school attendance and performance depend to a great extent on their parents' interest and monitoring. Finally, it was seen that students who perform well in school feel good about themselves and their future and do not want to jeopardize it through risky behavior that may have long-term repercussions-which provides some partial evidence that positive experiences in school can have a longer-term impact. 5.24 On the other hand, macro data shows an increase in the rate of violent crime over the last fifteen years, even as the overall enrollment rate in school has increased and illiteracy has gone down. Several factors account for this apparent inconsistency, stemming to a large extent from inequality in multiple dimensions (see also next section). The general increase inenrollment masks the inequality in access (enrollment and income loWhile there are many other influences on fertility, includingfamily planning,education, especially of the mother, is akey factor inreducingfertility. " Datafor 15695 childrenin school, aged 10-18, including2635 from Jamaica. See World Bank (2002a)for more details. 108 are highly correlated for older children)-for example, within the poorest quintile, the percentage of 15-16 year olds not enrolled in school has stayed between 29-35 for most years between 1991-2001 (32% in2001, 35% in 1991), and this situation creates a host o f problems. Given that youth under 24 i s the most vulnerable age group-this group committed 55% of all crimes in 1999-the substantial percentage of 15-16 year poor children that are out of school renders a large number o f poor children, largely male, susceptible to engaging in crime and violence. For those out of school, there i s no opportunity to receive positive and reinforcing support from the school system, as described above. Nor are the out of school youth likely to find employment and thereby be gainfully occupied-unemployment amongst 14-19 year youth was 47% inApril 2001 (37% males, 65% females), and 28% amongst the 20-24 group, versus 15% for all age groups. Moreover, young people who did not complete secondary education (i.e., including all the 15-16 year olds who are out o f school) suffer the highest rates of unemployment. 5.25 Thus, it seems that receiving education in the school system influences the large majority of children in a positive way. Almost 90 percent of parents in the 2001 SLC rated their children's schools favorably. Crime begins when children start dropping out of school, which happen to be largely the poor children, owing largely to inadequate places in traditional schools after grade 9, as well as to a continuous cycle of low achievement and resultant alienation from school. The problem of crime, then, can be linked to the lack of a quality education and a positive school experience. V. INEQUALITY,POVERTYAND STUDENTACHIEVEMENT 5.26 While opportunities have expanded, the quality of education continues to languish. Challenges lie in low achievement (about 30-40 percent functional illiteracy at the end of primary education), high absenteeism (full attendance in school is 78 percent), especially injunior secondary education, disengagement of adolescents from educational pursuit and their tendency to drop out before completion of the cycle. The latter problem i s more pervasive among boys than girls. Apart from these, there is also an issue of access at higher levels-22 percent of all students enrolled in grade 9, or about 11,000 students, cannot access grades 10 and 11 because of the lack of school places. All the above problems stem at least partly from inequality and poverty, including the family environment, as well as the historical evolution of the school system (Section 111). 5.27 With increasing age, enrollment of the poor and o f males suffers. Figure 5.2 shows that while enrollment ratios of the richest and poorest quintiles start out at the same levels, they diverge sharply after age 14. By the ages o f 15 and 16, less than 80 percent of students from.the poorest quintile remain in school, although all students from the top quintile continue with schooling. By the ages of 17 and 18, less than 30 percent of students from the poorest quintile remain in school, while even in the top quintile, less than 80 percent stay enrolled. Although males and females start out equally in enrollment in basic education, a disproportionately high number of males drop out after grade 9, so that by the time of tertiary education, females account for about 66 percent of enrollment. Thus, boys dominate the population of out of school 12-18 year olds who 109 have completed grade 9-in 2000, males formed 61 percent of this population (2000 SLC). Figure5.2: School Enrollment by Age and Consumption Quintile,2000 3-5 6-11 12-14 15-16 17-18 19-24 Source:PIOJ-STATIN2001 Age Groups 5.28 Table 5.2 presents enrollment by school type and by consumption quintile. About 43 percent of students in all-age schools in 2000 were from the poorest quintile, while over half of the students in the academic, traditional high schools were from the top two quintiles. Given that all-age schools are largely in rural areas, and do not go beyond grade 9, about 60 percent of the out-of-school population lives in rural areas, which also partly explains why poverty i s much higher in rural areas (Chapter 1). In tertiary education, 77 percent of students were from the top uintile, and 91 percent from the top two quintiles, but none are from the poorest quintile. 19 Table 5.2: Enrollmentby School Type in Secondary and Tertiary Education by ConsumptionQuintile("h),2000 Q1 (poorest) Q2 Q3 Q4 Q5 (richest) Total All-age (Gr.7-9) 43 30 18 6 3 100 P&JH(Gr. 7-9) 22 16 19 33 10 100 Comprehensive(Gr. 7-11) 18 24 27 18 13 100 Secondary Highs(Gr. 7-13) 13 17 20 25 26 100 Technical Highs(Gr. 7-11/13) 11 20 15 31 23 100 Voc./ Agricultural(Gr. 7-11) 11 12 39 27 11 100 AduWNight 12 0 14 24 51 100 Tertiary 0 2 7 1 4 77 100 Source:JamaicaSurvey of LivingConditions 2000, PIOJ-STATIN2001, 5.29 The quality of schools is very uneven. About 30 to 40 percent of Grade 6 leavers read below grade level. Since placement in Grade 7 has been universal since the late 1990s, the under-achieving students tend to lag further as they move into higher grades (see also sub-section on Inequality below). This can be seen inthe following: '* Given the small sample size for tertiary students, the ratios tend to fluctuate. In 2001, 5 percent of tertiary students were from the poorest quintile, and 86 percent for the top two quintiles. 110 In the Junior High School Certificate Examination (JHSCE, end of grade 9), the students in Primary and Junior High Schools and the former Comprehensive High Schools scored much lower on average than the Traditional High Schools (Figures 5.3 and 5.4), in mathematics and language. These outcomes have significant long- term effects-the weakness in reading impedes the students' ability to master other curricula and also to learn on their own. The weakness in mathematics impairs seriously their ability to comprehend science as well as social sciences that rely on quantitative research methods. Figure 5.5 shows that less than half of the students inthe former Comprehensive High schools participate in the Caribbean Secondary Education Certification Examination of the regional Caribbean Examination Council (CXC, taken in grade ll), is which the key examination for admission in tertiary education and employment. For those who participate, the variability in pass rates across different school types i s large. (Figure 5.6). The academically oriented High schools employ a higher proportion of university- educated teachers. Despite progress in recent years, the highest proportion of untrainedteachers i s concentrated in schools serving rural communities. Figure5.3 Figure 5.4 Percent Correct in Mathematics, Percent Correct in Language, Junior High School Certificate Examination, Junior High School CertificateExamination, 1997-2000 1 1997-2000 I 100 - 100, 80 6o 20 - 40 0 - I ,--1 1997 1998 1999 2000 2oL--7 0 1997 1998 1999 2000 -+- Tradifonal+Comprehen. &P&JH Comprehen. +P&A Figure 5.5 Figure 5.6 1 Percentageof EligibleCohortTaking CXC, 2001 Percentageof Total Passes of CXC Candidates, 1I ~ 2001 9090 80'. 8C". 70'0 60'0 50'. 50'. OSecmaay n grs 40'0 40'0 FormerComprehensii 30a, Former Comprenensyes 3090 20'0 20'. 100. 10'. I 0'0 0'. Maths English ~ Maths English Secondary school studentshave to pay rental fees to access textbooks, and data shows only about half the students avail of this, in spite of public financial support for the 111 rental scheme. This affects the poor disproportionately, since the richer ones can in any case afford to buy the books. Moreover, High Schools can charge fees to the extent of 14 percent to defray operating costs, which i s used to acquire library books and instructional materials. However, since the All-Age and P&JH schools cannot charge fees, their libraries are either non-existent or poorly resourced. Without reading materials, there i s little surprise that functional literacy i s low in such schools. Ironically, these schools, which serve the most disadvantaged students, also have the least discretionary resources for improvement, to organize compensatory education, or to support activities that would create incentives for students to stay in school. 5.30 Poor students face multiple disadvantages. Richer children receive better quality education. Students from affluent families tend to attend private preparatory primary schools and pay for extra tutoring to prepare for the end of the primary cycle (grade 6) examination. Being better prepared, they tend to have higher test scores, which allow them to be placed in the selective, Traditional High Schools. Such tracking of students into different types of secondary schools o f very uneven quality i s widespread. School quality i s also one among several reasons for lower attendance amongst poor students-in 2001, only 60 percent of the poorest students had full attendance (attended school for all 20 days in a reference month), compared with 87 percent o f students in the richest quintile. The Kingston area had the highest attendance rate o f 90 percent, while rural areas had 74 percent (2001 SLC). 5.31 Poor quality of schooling and a disadvantaged home environment are mutually reinforcing. Many students tend to come from unstable home environments, which are exacerbated by migration, with family members migrating overseas serially, with children left behind for years. Females head 43 percent of households, and almost one- fifth of children do not live with either parent. 5.32 In tertiary education, as seen above, 91 percent of students are from the top two quintiles. Poorer students also have more unstable home environments, and live in homes with a greater chance of not having a father figure (in 2001, 51% o f poorest quintile and 37% of richest quintile households were female-headed). 5.33 Many fathers are in the home irregularly, have multiple mates and children with more than one mate (Blank and Monowa, 2000). The absence of a male role model has an adverse effect on the development of adolescent boys, contributing to their lower achievement andearly dropout. Low academic achievement has a strong bearing on their subsequent educational aspirations, absenteeism, the risks of dropout and delinquent behavior. 5.34 Facing such severe handicaps, it i s not surprisingthat those who do not participate in the CXC examinations or fail to pass them tend to be predominantly the poor. Table 5.3 shows that the adult population in the bottom quintile has disproportionately fewer academic qualifications-86 percent of the poorest quintile possess no academic qualification, compared with 52 percent for the richest quintile; none of the poor had a tertiary degree, while 12 percent of the richest quintile did. Looking at it another way, 112 the richest quintile forms the vast majority of those with degrees or those with 3 or more A levels. Table 5.3: Highest Examination passed by population 14 years and over not enrolled in SchoollEducational institution ("h),2001 Q1 (poorest) Q2 Q3 Q4 Q5 (richest) None 86.1 88.4 80.6 72.7 52.3 CXC Basic 6.8 5.2 7.9 7.5 7.1 GCE/CXC General, 1-2subjects 2.1 1.3 3.3 3.7 3.2 GCE/CXC General, 3-4subjects 1.9 0.9 1.4 4.1 7.9 GCEKXC General, 5 t & 1-2A Levels - 0.4 1.7 1.9 4.5 GCE A Level,3 t subjects - 0 0.2 0.3 0.5 Degree - 0.5 0.8 1.6 12 Other 1.3 0.2 1.1 4.7 8.9 Not Stated 1.7 3.2 3.2 3.6 3.6 Total 100 100 100 100 100 Source:Jamaica Survey of Living Conditions2001, PIOJ-STATIN2002. VI. OUTCOMESAND PUBLICEXPENDITURE 5.35 Jamaica's weak CXC outcomes. Section I11 above showed that returns to Jamaican-educated labor in the USA were lower than for most other countries in the sample, and Section V discussed the low average achievements inprimary and secondary schools. Similar results are seen in the CXC examinations (for 2001)' where Jamaica i s out-performedby many Caribbean countries in the CXC (Figure 5.7). Jamaica's national pass rate of under 60 percent in CXC English examinations and 30 percent in mathematics i s below that of Dominica, St. Kitts, St. Lucia, Belize, Trinidad and Tobago, and St. Vincent and the Grenadines (SVG).I3 5.36 Real expenditure has been increasing. In real terms and as a share of GDP, Jamaica's expenditure on education has increased substantially over the 1990s-from 3.4% of GDP in 1992/93 to 6.8% in 1997/98 and 6.1% in 2001/02, and with real expenditure more than doubling over the period. 5.37 to GDPratio "...often bears a weak relationship to measures of output of the education Expenditure does not guarantee outcomes. The public education expenditure l3An overall judgment on the relative efficiency of the systems in Caribbean countries would also take into account the completion rates at different levels of schooling. In Jamaica, the combined survival rates (combining survival till first and last grade of secondary school) are higher than all the above counties, which means that a higher percentage of students that initially started in the primary system survive to take the CXC examinations. While this may provide some small comfort, the fact remains that the Jamaican system results in poor and skewed overall outcomes, as noted above. See World Bank (2002d). 113 Figure5.7: CXC Performancein nine Caribbean Countries 90 - Belize Dominica Grenada Guyana Jamaica StKitts StLucia SVG i-r share of GDP than 6 of the 8 other Caribbean countries in the sample above, with poorer outcomes than many countries where Governments spend less. One reason for this could be lower instructional time-Jamaica has the lowest number of classroom hours in secondary education among eight Caribbean countries, as Figure 5.8 shows, partly because crime and civil disturbances force school closures. Figure5.8: EnglishCXC passing rate (%) and class hours in eight Caribbeancountries 1 I 80 1 \ DOMINICA ST K I T S & NEVIS + 70 - +BELIZE JAMAICA? + +STSTLUCIA VINCENT & THE GRENADINES I GRENADA I ! GUYANA 2o 10 1 I I I I I I ~~~ -7 0 200 400 600 800 1000 1200 1400 1600 Class hoursin secondary 5.38 Distribution of public expenditure is inequitable. There are some serious problems in the distribution of public expenditure. The Lorenz curve (Figure 5.9) shows that public expenditure on early childhood, primary, and secondary education i s equitably distributed amongst rich and poor students. However, tertiary education expenditure i s distributed very inequitably, with the top quintile receiving 77% of the expenditure, which i s not surprising given the enrollment patterns. Also, per student recurrent expenditure i s much higher for tertiary education (US$3464 in 1999/00), compared to US$85 in early childhood, US$313 in primary, US$1925 in special education and 114 US$533 in secondary education. As a result, overall education expenditure i s regressive, with the top quintile getting 34 percent, and the bottom two quintiles getting 32 percent. 5.39 Given that the bulk of tertiary students are from the top two quintiles (91 percent in 2000), a strong case can be made for higher cost recovery in tertiary education. Currently, the government finances 55-6096 of the budget (salary and related items) of Utech and community colleges, 70-8096 (salary and related items, and some recurrent costs) for teachers' colleges and 80% of the budget of the University of the West Indies. This implies a further inequity within the category of those who have access to tertiary education, since community and teacher colleges serve students from relatively less well- to-do families. A graded increase in fees over time within the different categories of tertiary institutions will reduce inequities and generate some much-needed resources for the public exchequer. I Figure 5.9 Lorenz Curve Distribution of Public Recurrent Expenditureby Level of Education and by Consumption Quintile, 2OOO I 0 0.2 0.4 0.6 0.8 1 -- - I Propor$m of Population Lineof PerfectEquality - (N=427) Primary (N=936) Secondary (N=662) --Terbary- - Preschool(N=43) o w e : Constucted from PIOJ-STATIN,2001 5.40 Teachers' salaries are part of the general wage malaise. In2001/02, recurrent expenditure was 98 percent of the total public allocation for education, with wages around 78 percent. As i s the norm, the share of wages i s much higher inthe earlier stages of the education cycle. But there are several problems in the teacher wage patterns: (i) wages have increased too fast; (ii) starting salary for a teacher i s 2.6 times (with no the pedagogical training) to 5 times (trained graduate) per capita GDP, while the average in the USA and Latin America is twice per capita GDP; (iii)there i s severe wage compression, with the difference between the highest and lowest teacher salaries 16-18 percent, making teacher retention difficult. The implication of all this i s at least at the earlier stages of the education cycle, the salaries to total expenditure ratio i s too high, and have reduced the amounts left over for instructional material and maintenance. 115 VII. WHAT HASBEENDONEAND WHAT MORE CANBEDONE? 5.41 The 1990s reforms. The MOEYC (Ministry of Education, Youth and Culture) embarked on a series of far-reaching education reforms inthe 1990s, including: Services for early childhood development, from birth to six years, were integrated under MOEYC. Early Childhood Education (ECE) enrollment expanded quickly, from 75 to 91 (88 percent in the poorest quintile) percent over 1992-2001, and the goal i s 100 percent enrollment. In primary education, continuous efforts have been made to enhance quality, provide free textbooks, improve student assessment in Grades 1, 3, 4 and 6, upgrade infrastructure of Primary, All-Age, and P&JH schools, provide pre-service training, update the curriculum of teacher in-service training, and increase the focus on literacy. Beginningin 1999, students at Grade 4 are tested to determine whether they read at grade level-automatic promotion i s no longer permitted after grade "and to determine remedial measures. In secondary education, the most stratified sub-sector, MOEYC introduced a common core curriculum in Grades 7 to 9 to equalize the educational opportunity across all school types, and to balance academic and future vocational demands. Targeting five core subjects (Mathematics, Language Arts, Science, Social Studies, and Resource and Technology) and career education, it aims to develop, inter alia, effective oral and written skills, numeric and problem-solving skills, and critical and creative thinking. A new Grade 9 test was developed to provide more valid and reliable measures of performance for diagnosis, placement and/or certification purposes. School types were reduced from seven to five through upgrading. In tertiary education, cost sharing was increased to 20 percent of the economic cost while providing student loans and grants to the needy. The government has also permitted private higher education institutions as well as foreign universities to operate/offer courses inJamaica, helping to broaden tertiary education opportunities. 5.42 The Government's White Paper: Education the Way Upward (February 2001) seeks to consolidate the gains of the 1990s and provide a broader vision to guide education reform inthe medium term. The White Paper emphasizes quality education for all and life-long learning in an era of globalization and technological change. It seeks to: 0 Reiterate the importance of early intervention to compensate for poverty and a disadvantaged home environment, improve readiness of children in primary education, and attain 80 percent functional literacy at the end of Grade 6. 0 Provide a place inupper secondary education for every Grade 9 leaver by 2007, to increase high school students' participation and pass rates inthe CXC. Increase enrollment in tertiary education to 15 percent of the relevant age cohort. 0 Decentralize school management, stressing participation, performance and accountability, initiate institutional contracts, and make school performance public. 116 Protect education's share to at least 15-20 percent of the recurrent budget; offer financial assistance for book rental, fee remission and CXC examination fee subsidies for the needy to reduce inequities incost sharingpolicies. 5.43 Within the overall framework suggested by the White Paper, it is suggested that some re-prioritization and modification could lead to more effective outcomes, as outlined below. 5.44 Focus on early learning and raise the functional literacy target to 100 percent. The testing of students at Grade 4 to diagnose learning problems could be advanced to lower primary education to bring all students to standard in their very first few years of school experience. In effect, the target should be for all students to read at grade level in every grade and be functionally literate and numerate by the time they graduate from primary schools. It also means enhancing the target of 80 percent functional literacy after Grade 6 to 100 percent, or else continue to run the risk of functionally less literate becoming part of the problem of youth at risk. There i s no higher priority in education than this one because without strengthening the foundation, all subsequent interventions are likely to be more costly and ineffe~tive.'~ This may need some re-orientation of public expenditure on education. 5.45 Effective early interventions entail: (a) hiring and training specialist teachers in reading and math; (b) making available high interest learning materials (including in Patois, since the majority of students speak Patois, and take time to learn English) and games in order to engage children; (c) vigorously and frequently assessing students' achievement and learning problems; (d) organizing co-curricular activities and extra tutoring to help slow learners catch-up during the week and holidays; (e) providing summer school programs for those who still need additional help; and (f) having smaller class sizes and deploying the best teachers for the lower primary grades, in keeping with the findings of education research. 5.46 International benchmarking. It is important to have some sense of how Jamaican students perform vis-&vis students in other countries, especially those known to have good education outcomes. This can be achieved by regular participation in international comparative studies such as E A Mathematics and Science Studies and Literacy Studies, and OECD's PISA Study on knowledge of 15 year-old-students. Such studies are repeated every few years and provide an opportunity for evaluating and redesigningpolicy interventions. 5.47 Increase parental involvement and awareness and make school results public. Many of the bottlenecks to learning originate from the home. Greater involvement of parents in child development can provide a major boost to student achievement. Publicity campaigns, including through mass media, are needed to inform parents that: differentiated expectations for boys and girls can affect their future aspirations; building trust rather than physical punishment helps child self-discipline; l4Post-war success stories like Korea and Scandinavian countries, and the USA between 1850 and 1950, have all followed apatternof bottom-up upgrading, starting with the developmentof basic education, followed by secondary and then tertiary education(World Bank 2003, Chapter 4). 117 story telling and reading or use of audio tapes can help children learn standard English; books are essential for learning, and parents should provide for their rental or apply for public assistance for rental; regular school attendance and doing homework will help child achievement; better educated children are better able to take care of old age parents and help their own children attain better health and education outcomes. Parenting education also means informing fathers about their critical role in their sons' development and single mothers about good practices in rearing responsible children in general. All this i s not very resource-intensive but demands organized, systematic and sustained efforts. On their part, schools could make their results public, which would enable parents and the community to monitor school progress. 5.48 Encourage student involvement. On their part, schools should systematically encourage students and involve them in efforts at school improvement, encourage student self-government, provide students some discretionary funds to address issues of concern to them, and thereby also get them more engaged inthe process of school-building. 5.49 Expand upper secondary education. 'The sharp decline in enrollment of students after age 14, especially the poor, can be attributed to the lack of school places in Grades 10 and 11, as well as poor preparation in junior secondary education. Students from All-age and P&JH schools, which offer only 3 years of junior secondary education, are more affected by the lack of supply than others. One cost-effective and quick way to provide school spaces would be to buy seats in private schools that target and achieve quality improvement, making capitation grants available to them based on their enrollment of students in Grades 10 and 11(see also below). Private schools can also be paid to organize compensatory education to repeaters. 5.50 Improve teacher incentives and school-based management. Generally, a teaching career i s not the first choice of high-achieving students. Over the years, teachers, particularly in mathematics and science, tend to leave teaching when they find opportunities in other sectors. Also, inrecent times, some of the best and most promising teachers from Jamaica have been regularly recruited by New York City and the UK. Given that teachers are the most critical factor in education outcomes, motivating and retaining quality teachers becomes crucial. 5.51 Tackling this will require restructuring teacher salaries over time-not increasing them generally, since they are already high-to reduce the current compression at the top end, which is perpetuated by the practice of applying a uniform percentage increase for all scales. Smaller percentage increases for pre-trained teachers will free up resources for the top end of the scale and encourage professional upgrading of less qualified teachers. 5.52 Monetary reward i s not the sole motivating factor. Currently, the Jamaican Teachers' Association provides the best teacher award on an annual basis, and allows the awardee to interact with other teachers at an international conference. This laudable effort could be extended to every school by having students and parents select the best teacher and provide appropriate recognition in the community. Colombia has implemented this scheme with much success. Another way to empower teachers and give them a sense of ownership i s to permit them key roles in school-based management. 118 Teachers could be encouraged to set targets and design strategies, based on student data, and be given discretionary funds to meet these challenges. 5.53 Increase flexibility in teacher deployment. The current practice of using students-to-teacher ratios as a basis of allocating positions (andhence public resources) to schools and of associating teachers with the schools that hire them rather than with the Ministry, has some built-in rigidities. Once a school hires a teacher (with employment authorized by the Ministry), he/she cannot be re-deployed to another school or be retrenched from the system even when the student enrollment declines. These rigidities have led to some schools having very low student-to-teacher ratios, with others in high growth areas having unreasonably high ratios. A more flexible arrangement needs to be negotiated with the union. 5.54 Reform Education Finance. Subventions to schools are based on the number of teaching positions approved, which, in turn, are based on recommended student-to- teacher ratios for each school type. Since the ratios vary across school types, the basis for resource allocation i s inherently unequal. To level the playing fields for all secondary schools (including All-Age and P&JH Schools which have Grades 7 to 9), public resources should be allocated as capitation grants based on enrollment (verifiable as average daily attendance) for all school types. In the case o f All-Age and P&JH, the capitation grant for Grades 7-9 should be more equivalent to per student spending inHigh Schools than to primary schools. Since the average daily attendance has to be verified by periodic, unannounced inspection, this will also provide incentives for schools to encourage student attendance and keep good records. 5.55 Capitation grants have another advantage. Currently, there i s little incentive for school boards not to hire the maximum number of teachers that the establishment permits. Basing allocation on enrollment allows capitation grants to be de-linked from student-to-teacher ratios and permits greater flexibility in the system. For example, the school board and teachers could decide to use part of their funds to purchase some learning material rather than hire a teacher. Allowing schools to make such decisions would increase the efficiency of resource use. 5.56 Equalizing resource allocation across school types i s not enough to provide a level playing field for disadvantaged students. Special grants may be needed to support schools that, for example, have a large percentage of students reading below grade level. Compensatory education could be funded through this mechanism. Many schools need far more and better quality library resources and reading materials. 5.57 Some discretionary funds to finance co-curricular activities for students, and professional development activities for teachers, would also help schools to engage teachers and students. The Reform of Secondary Education Project I1i s providing an experimental school improvement grant on a three-year basis. If effective, it could be institutionalized. 5.58 Buying places from private sector schools that target and achieve quality improvement, rather than constructing new secondary schools, i s likely to be a cheaper 119 and more flexible alternative for government, and provides immediate access to students who don't have to wait for new buildings to come up. Currently, private secondary schools absorb about 5 percent of total students. However, they have excess capacity (and so usually have smaller class sizes than public schools) and struggle to cover operating costs, because the public system i s free or charges only a fraction of private school fees. For each new student, a private school could be paid the equivalent of average per student recurrent spending on secondary education in the public system, which would save government the costs of capital investment as well as repair and maintenance. To take care of quality concerns, this scheme could be introduced in an incremental way, starting with those private schools that have good results, and moving on to those that achieve quality targets which can be monitored. This partnership with the private sector also gives the government the flexibility to adjust to the changing demographics of the school-age population. 5.59 In tertiary education, given its relatively high quality, the richer than average profile of those who attend, the high emigration rates, and the high private returns to education, increasing cost recovery would be desirable on both equity and efficiency grounds. For the same reasons, the student loan scheme should draw on private rather than public resources (the current scheme has not been financially self-sustaining). In this context, improving the quality of statistics on student repayment and default would help, and public disclosure of those who do not repay would mount public pressure on students to repay. 120 CHAPTER 6: CRIME AND ITS IMPACT ONBUSINESSINJAMAICA' I. INTRODUCTION-CRIME ANDDEVELOPMENT 6.1 Jamaica has the one of the highest rates of violent crime in the world, but a relatively low rate of property crime. In2000, the recordedintentional homicide rate was 33 per 100,000 inhabitants, lower only than Colombia (63) and South Africa (52)*. In terms of recorded major assaults, Jamaica experienced 215 such incidents per 100,000 (665 in South Africa, 95 in Dominica). Recorded drug offences are also among the highest in the world, at 452 per 100,000 (370 in Dominica, and highest at 987 in Norway). In contrast, property crimes are relatively low in Jamaica: recorded burglaries occur at a rate of 92 per 100,000 (1777 in the Dominica, 922 in South Africa, 134 in Mauritius), and total robberies at 89 per 100,000 (78 in Dominica, 460 in South Africa, 98 in Mauritius). In the aggregate, Jamaica experienced a relatively lower 1488 total recorded crimes per 100,000 in 2000 (10763 in Dominica, 7997 in South Africa, 3030 in Mauritius, 1289 in Costa Rica), since non-violent crimes are fewer in Jamaica, but where there i s also significant under-reporting owing to low clear-up rates. 6.2 A highrate of violent crime can have many adverse repercussions: 0 It has a negative impact on the investment climate and can deter or delay both domestic and foreign investment, and hence growth. 0 It leads to higher cost of doing business, because of the need to employ different forms of security, and diverts investment away from business expansion and productivity improvement, and may lead to a less than optimal operating strategy. It leads to business losses, arising from looting, arson, theft, extortion and fraud. It leads to loss of output because of reduced hours of operation (including avoiding night shifts) or loss of workdays arising from outbreaks of violence, and avoidance of some types o f economic activity. It also reduces output because of the temporary (from injury)or permanent (from murder) exit of individuals from the labor force. In the latter case, the loss i s not just current output, but the output in the remaining years of the individual's working life. It can also cause a permanent shut-down of firms or relocation to less crime-prone countries. 0 It erodes the development of human capital as well as social capital and thus constrains the potential for growth. The crime situation inJamaica seems to be an important reason for migrati~n,~since the fear of crime significantly reduces the 'The analysis on crime in this Chapter is based on a backgroundpaper prepared for this study by Harriott *etSource: al., 2003. website of Office on Drugs and Crime, Centre for InternationalCrime Prevention, United Nations. See "NDM predictsbraindrain," Jamaica Gleaner,January 6, 1999. quality of life. Crime and violence have also been blamed for slowing down the rate of return of migrants back to Jamai~a.~Also, crime forces otherwise productive individuals to occasionally exit the labor force because o f violent injury to themselves or close associates, or because of social unrest in the community. Violence in some communities also causes schools to close periodically. Moreover, home and community instability i s not conducive to learning andeducational objectives. It diverts public resources excessively away from productive uses5that have a potentially much higher impact on social development and growth, to areas such as police, justice, the medical system (for treatment of violence-related injuries and trauma). For example, between 1988/89 and 2001/02, Jamaica's budgetary expenditure for health, in nominal terms, grew 23 percent annually, whereas the budget for national security and justice grew by 62 percent. Since 1999, the budget for Justice and Correctional Services plus the Police has exceeded the budget allocation for health (PIOJ, various issues). For private citizens, it also diverts resources away from potentially useful expenditures like education, to spending on treating injury and on private security. 6.3 This report estimates that the direct cost of crime inJamaica is at least 3.7 percent of GDP (2001 data)6, and this does not include the impact on business. O f course, the causality also runs in reverse. Crime may result, for example, from the effect of broad socio-economic and political processes, and the outcome of distortions such as chronic unemployment and highlevels of inequality. 6.4 How should the crime problem be tackled? A balanced approach i s needed that addresses social factors, reduces inequality (especially inequality that i s not derived from differential effort and performance), and improves educational achievement (not just enrolment), as well as ensuring effective and fair law enforcement. Many recommendations have been made in official reports in Jamaica (PERF 2001; Wolfe 1993), but these reports have not attempted to estimate costs of crime and crime control measures (these will be addressedinthis chapter). 6.5 This chapter attempts to better understand the dimension and sources of the crime problem in Jamaica. A Business Victimization Survey of 400 firms was carried out for the first time in Jamaica for this report. Victimization surveys are useful because they include crimes not reported to the police, provide information on perceptions o f risks from crime, and assessments of the institutional support available to cope with crime. The results of this survey, based on perceptions and experiences of crime by managers, are discussed in detail in the chapter. The recommendations in this chapter are based directly on results from the survey and econometric analysis (see Annex 6.1). The chapter does not attempt to cover all angles of the crime problem in depth (e.g. many aspects of youth violence, domestic violence, gang or drug related crimes), but aims to "Jamaicans staying away from home," Jamaica Gleaner,December 5, 1999. Incomparison with a more peaceful society. This is a static estimate of the cost of crime during the year, and is calculated as the sum of healthcare costs, lost production days, and public security expenses. 122 focus on the impact of crime on businesses and the economy and provide recommendations that emanate directly from this analysis and from cross-country experiences. 6.6 This chapter is organized as follows. Section I1sets the context for analyzing crime by providing an overview o f Jamaica's governance performance and its ranking in international governance indicators. Section I11surveys the dimension o f and trends in crime over the last three decades. The patterns of criminal victimization of business enterprises are discussed in Section IV to appraise the direct impact of crime on economic activity. In Section V, the economic cost of crime i s estimated, using data from the survey as well as public records and budgets. In Section VI, the determinants of violent crime are briefly discussed based on the results of a time series econometric estimation. InSection VII, policy recommendations are presented. 11. GOVERNANCEINJAMAICA THE INTERNATIONAL CONTEXT - 6.7 Jamaica has a strong democracy, high caliber bureaucracy and good regulatory framework. Since its independence in 1962, Jamaica has been a stable democracy, led alternatively by the People's National Party (PNP), currently in power since 1989, and the Jamaica Labor Party (JLP). The thirteen parishes of Jamaica are governed by local authorities called Parish Councils. Political participation i s widely exercised with a voter turnout o f about two-thirds at general elections. Jamaica's tradition of democratic participation, free media, civil liberties and political rights, are substantiated by international surveys based on perceptions, where it ranks high in terms of `voice and accountability' and `political stability and lack of political violence' (see Table 6.1). The quality of the bureaucracy i s ratedincross-country comparisons as high, comparable to countries such as Chile, Hong Kong and France. The public sector accounted, in April 2002, for about 10% of the labor force (97285 employees, of which 32067 were civil servants) inJamaica. 6.8 In addition, Jamaica has a positive enabling environment for business establishment and operation. It ranks high in international comparisons of its regulatory framework -it requires 37 days to start a firm in Jamaica, comparable to 34 days inChile. Labor regulations are not perceived to be too onerous (the labor regulation index for Jamaica i s 2 on an index from 0-6, where 6 i s the highest level of regulation7). Major steps have been taken by the Government to improve the framework for competition, such as the passage of the Fair Competition Act, the establishment of the Fair Trading Commission and the Securities Commission (to regulate the securities industry) in 1993. The financial crisis of 1996 prompted legislative initiatives, including a new Financial InstitutionsAct, Insurance Act, as well as amendments to the Banking Act, Securities and Unit Trust Acts and to building society regulations. Three Bills were passed by the Senate in 1999 to safeguard property right inthe areas of trademark, copyright and layout designs. 'WorldBank,snapshot reports, http:/rru.worldbank.org/doingbusiness/TopicReports. 123 6.9 However, strengths have not converted into comparable outcomes (see Figure 6.1). Public satisfaction with government policies and the government's ability to carry out its declared programs are below average in the cross-country comparisons. This public dissatisfaction could be partly explained by the perception that quality of public service provision (captured by government effectiveness) i s relatively below average. 6.10 Also affecting the business environment i s corruption, where Jamaica scores on average in cross-country surveys o f perceptions of corruption (see Table 6.1).8 Yet bribery and lack o f transparency in government contracts are considered by Jamaicans to be important problems. Jamaica ranks poorly in perceptions of favoritism shown by government officials towards well connected firms and individuals when deciding upon policies and contracts. This i s closely linked with the pressure exerted on businesses by the protection racket, and reflectedin the highperceived costs imposed on businesses by organized crime (such as racketeering and extortion, see section V). Figure6.1. Jamaica`sInternationalRanking,Selected Governance Indicators200212003, Average Rank(80 countries)4 0 0 1 200 7 f 150 100 50 0 BureaucracyQuality Law and Order Crime Costs Infrastructure Jamaica IIIDominicanRepublic OTrinidad & Tobago EdUS. Source: See Table 6.1 6.11 Inaddition, very poor rule of law and crime negates the positive elements in the business environment. Jamaica's most conspicuous and severe problem i s the erosion in the rule o f law. Comparisons of international ratings show that Jamaica i s significantly under-performing in the area of law and order relative to countries with comparable incomes per capita (see Figure 6.2). The rule o f law has been shown to have a strong statistical relationship to economic growth and poverty reduction.' Highrates of Anti-corruption legislation, the Corruption Prevention Act, was passed by Parliament in 2000. This requires select government employees to file annual assets statements with a three-member Corruption Prevention Commission (further reform should aim to give the commission independent investigative powers and increasedfinancial allocations). It is estimated that an improvement in Jamaica's rule of law to the high level found in the Bahamas, St. Lucia, or Trinidad and Tobago in 1998 would lead to about 50% more foreign investment, 2 percentage pointshigher growth, and improvedsocial indicators (World Bank 2000b). 124 Table 6.1 International Comparisons of Selected Governance Indicators, 2002, Scale 0 (worst). 6 (best) Jamaica Selected economies Full Sample % rank in sample Score Dominican Trinidad & Mauritius US. Sample Sample 100 best Republic Tobago Mean Size ~~ ~ i) Government Effectiveness and Stabiliv GovernmentEffectiveness(K. et al., 2001)' 43 45 2.6 2.7 3.7 3.9 4.9 3.0 159 SocioeconomicConditions(ICRG,Feb 2003y 2.5 2.8 3.0 3.8 2.9 140 Costs of lnstitutionai change (GCR, 200t)3 52 3.9 3.3 4.4 5.1 3.9 75 Voice and Accountability(Kaufmannet al., 2001)' 73 3.9 3.5 3.7 4.5 4.5 3.0 173 GovernmentStabilityilCRG, 2003f 35 4.3 5.0 4.0 5.3 4.5 140 Political Stability and lack of Pol.Violence(K. et al., 2003f 7661 3.4 3.6 3.3 4.3 4.4 3.0 161 BureaucracyQuality (ICRG,2003)7 4.5 1.5 4.5 6.0 3.3 140 ii) Rule of Law and Business Environment Law and Order (ICRG,2003) 4 1.0 2.0 3.0 5.0 3.7 140 Organizedcrime (GGR)' 5 2.1 3.6 3.9 5.1 4.9 4.0 80 Reliabilityof Police Forces(GCR) 25 2.7 2.9 3.3 3.2 5.3 3.7 80 Business Costs of Crime and Violence (GCR)' 9 1.9 3.0 2.9 4.2 4.7 3.8 80 RegulatoryFramework(K, et ai., 2001)" 68 3.5 3.7 4.0 3.5 4.4 3.0 168 Property Rights (GCR)" 51 4.2 3.2 4.2 4.6 5.4 4.0 80 Judicial Independence(GCR)'' 55 3.8 2.8 4.5 4.2 4.9 3.6 80 Favoritismin decisions of governmentofticials (GCRf3 34 2.4 2.1 2.4 2.8 3.7 2.8 80 Extentof bureaucraticred tape (GCR)" 38 3.9 4.0 3.7 4.0 4.2 3.9 80 Administrative burdenfor startups (GCR) 19 2.7 3.3 3.9 3.9 5.0 3.5 80 Hiringand Firing practices (GCRY' 45 2.7 3.3 3.3 2.1 4.5 3.0 80 Days to start a firm (GCR) 71 37.0 117.0 5.0 72 Flexibility of Wage Determination(GCR) 68 4.5 4.5 4.5 2.7 5.3 4.0 80 infrastructureQuality (GCR) 34 2.8 3.1 3.7 3.8 5.7 3.6 80 Corruptionand IrregularPayments(higherscale means less) Control of Corruption(K. et al, 2001) 54 2.9 2.8 3.6 3.6 4.7 3.0 160 Business costs of corruption(GCR) 48 3.9 3.2 3.9 4.1 5.1 4.1 80 IrregularPaymentsin Public Contracts (GCR) 25 3.0 3.6 3.1 3.1 4.8 3.6 80 Memo: GDP Der capita, PPP $ (2001) 3890 6198 10018 10400 34888 'quality of pubiic service provisionand bureaucracy,competenceof civil servants, independence of civii service from politicai pressuresand credibiiity of the governments commitmentto policies. 'general public satisfactionwith the government'seconomic policies; socioeconomicfactors are identified with greatest politicai impactfor the country. 3effectof legal or politicalchanges over pastfive years on firms planning capacity. 'extent of civii participationin political process,extent of civil liberties and political rights, including independenceof media. 'government's ability to carry out its declared program($ and its ability to stay in office. 'likelihood that a governmentin power will be destabilizedor overthrownby possible constitutional and/orviolent means. 'mechanism for recruitmentand trainingand autonomy of bureaucracyfrom political pressure. 'cost imposed on businessesby organizedcrime such as racketeeringand extoition. 'cost imposed on business by commoncrime andvioience (e.g. street muggings,firms being looted). "incidence of market unfriendlypolicies such as pricecontrols or inadequatebanking supervision, perceptionsof burdens imposedby excess regulationin foreigntrade and businessdeveiopment. I' extent to which financialassets and weaith are delineatedand protectedby law. "extent to which judiciary is independentand not subject to interferenceby the government. '3favoritism towards well connectedfirms and individualsby governmentofficials when deciding upon policies and contracts. time spent by company'ssenior managementworking with governmentagencied regulations. "extent to which hiring and firing of workers is impededlflexibly determinedby employers. Sources: InternationalCountryRisk Guide (iCRG) database, February2003: Global Competitiveness Report(GCR)2002103,2001102: GovernanceMatters 11: UpdatedGovernance Indicatorsfor 2000101,(Kaufmanet ai.), 2002. 125 violent crime im ose relatively very high costs to businesses in Jamaica (see Table 6.1 and Section V).I f Violent crime i s concentrated in the inner-cities among young males (see paras 6.21 and 6.22), giving Jamaica the third highest homicide rate in the world, andis sourced mainly through illegal narcotics and arms trafficking." 6.12 The highlevel of crime and violence has overloaded the judiciary with a backlog of cases, pending in high courts for over four years, in spite of the establishment of night courts to deal with minor cases. Though there are delays in the administration of justice, and legal and administrative practices are outdated and inefficient, the judicial system in Jamaica i s erceived to be relatively fair and independent from political pressures (see Table 6.1). 1! Figure 6.2: Jamaica's relative performance in Law and Order, 2003 (112 countries) 6 u.s 0 m 1m 1m 2 m 25000 30000 35ooo 40000 GDP per capita, PPP (current international $), 2002 111. DIMENSIONAND TRENDS INCRIMEINJAMAICA13 6.13 This section examines the basic patterns of reported crime over the last three decades (1970-2001) by analyzing the trends in crime and the geographic and economic distribution of crime inJamaica. loFor example, violence in Kingston in July 2001 is estimated to have cost Jampro more than US$lOO million in foregone foreign investments. In the case of the potential sale of Union Bank in 2001 to a foreign investor, the buyer was discouraged by the riots and left the country before even starting the discussions. I'Historically, political parties used violence and gangs to secure economic and political power and funded the arming of party supporters in local communities. When political parties withdrew from their sponsorship of gangs, the latter resorted to the drug trade and other illegal activities for resources (see Harriott 2000). l2 The reform of the judicial system has been undertaken by the government, including improving its administration and facilities, a Legal Aid Bill (to provide state-funded legal aid to the very poor), the establishment of a Justice Training Institute, and development of alternative methods of dispute resolutions. A proposal to establish a Caribbean Court of Justice as a final court of appeal i s being discussed between Jamaica and other CARICOM countries. l3Some of the survey work in this section is new in Jamaica and therefore subject to data constraints. 126 6.14 Trends in Crime. The trends in violent crime over the last thirty years place Jamaica among the most violent countries in the world. The Crime Rate Indices (CRIs)14 for Jamaica attempt to track movements in the overall crime rate for the last 30 years. There has been a relatively steady increase in the CRI over the decades (see Figure 6.3 and Annex Table 6.l), the highest rates of violent crime were experienced in 1980 though (a period of partisan political violence), followed by 1996 and 1997. The level of violent crimes and fraud were highest during the 1990s. It should be noted that under-reporting i s high for certain categories of violent crime partly because the clear up or arrest rates for these types o f crime i s fairly 10w.l~ 6.15 Over the 1990s, the murder rate increased steadily and was largely driven by increasing levels of distribution and trans-shipment of drugs, leading to increased "gang wars". Between 1998 and 2000, according to police reports, drug and gang related murders accounted on average for 22 percent of total murders. Domestic violence represented about 30 percent of total murders.16 The increasing severity of the murder problem i s highlighted by comparisons with New York, a high crime city - while both Jamaica and New York experienced similar rates of murder in 1970, Jamaica's murder rate had increased to almost 7 times that of New York's b y 2000 (see Annex Table 6.2). Figure 6.3: Trends in Rates of Major Crimes in Jamaica, 1970-2001(1990=100) 350 Shoobng 300 250 Murder 200 150 100 50 6.16 Some types of violent crime, notably shooting (i.e. assault with a gun) and robbery, have however seen a downward trend during the 1990s. Rape and carnal abuse levels increased up to the mid 1990s (possibly due to increased levels of reporting), declining slightly since then (may have resulted from establishment of a Rape Unit in the I4 Developed for Jamaica by Francis et al. (2001). The CRI includes only violent crimes i.e. murder, shooting, robbery, and rape and carnal abuse. Data for the past thirty years indicate that the percent of robberies cleared-up each year ranges from a low of 22 percent in 1991to a high of 45 percent in 1999.The thirty-year average i s 31 percent. I6 This may be an overestimate due to definitional and other difficulties. 127 Jamaica Constabulary Force). The fraud index shows an upward trend during the 1990s, duringwhich there was a significant increase inthe number of financial crimes associated with the rapid growth and inadequate regulation of the financial sector. 6.17 Geographicaldistributionof Crime. Jamaica i s divided into three counties and further into a total of thirteen parishes. Over 1984-2001, the county o f Surrey (eastern Jamaica) had the highest murder rates, rising from 41 per 100,000 o f population in 1984 (compared to the national average of 21 per 100,000) to 79 per 100,000 in 2001 (national average 44 per 100,000) (see Annex Table 6.3). The county of Surrey accounted on average for 61 percent of the total number of murders over 1984-2001 (while it represented an annual average of only 34 percent of Jamaica's population). 6.18 At the parish level, Kingston and St. Andrew had the highest murder rates, increasing steadily from 48 per 100,000 in 1984 to 93 per 100,000 in 2001. Kingston and St. Andrew averaged 57 percent of total murders during 1984-2001, but represented only 27 percent of Jamaica's total population. In 2001, about 51 percent o f reported violent crimes occurred in the city of King~t0n.l~The second highest murder rates occurred in St. Catherine, followed by St. James and St. Thomas. These parishes all have rapidly expanding urban centers. These trends reflect the serious social problems associated with growing urbanization, including high levels of unemployment, formation o f gangs, creation of slums, and an escalation of drug trafficking. Other forms of violent crimes, including shooting, robbery and rape," follow similar distribution patterns. 6.19 The Profileof those involvedin Crime. While violence is an endemic feature of Jamaican society, it i s often concentrated among the poorest in the society, and among young males (14-24 years old), who often tend to be the victims as well as the perpetrators o f violent crimes." In 2001, males accounted for 98 percent of those arrested for major crimes.20 Amongst those arrested for major crimes, 53 percent were from the 16-25 age group. Youth from inner cities are also more likely to be recruited as drug sellers because of their relatively lower opportunity costs, given that they are more likely to be school-dropouts/unemployed. Since drug sellerddealers carry guns for self- protection and dispute resolution, the increased penetration of guns has led to greater incidences of violence among the youth. IV. PATTERNS OF CRIMINAL VICTIMIZATION OF FIRMS AND COPING STRATEGIES 6.20 The business environment i s becoming more hostile and difficult. Some firms are inthe grip of organized crime, but this is still an emerging problem. Crime itself and the responses to it tend to be very costly in social and economic terms and may reduce competitiveness in some sectors of the economy and retard investments or even stimulate l7Includesmurders,rapes, shootingsandrobberies. l8While the county of Cornwall has the highest rates of rape, the county of Surrey has the highest ercentage of total rapes. '"PIOJ "World Bank (2001b). (2002). 128 disinvestments. International surveys rank Jamaica high in terms of the perceptions of the costs imposed on businessesby crime and violence (see Table 6.1). 6.21 In this section, the direct impact of crime on Jamaican businesses is explored. This analysis i s based on the results of a detailed business victimization survey of 400 f i r m s that was conducted in 2002 for this study, with a diverse sample in terms of size, location and sectoral origin21. Survey results are used to describe basic patterns o f criminal victimization of Jamaican businesses and perceptions of risk, and examine their coping strategies and the degree of institutional support given to them by the criminal justice system. The Patterns of Victimization 6.22 The criminal victimization of Jamaican firms i s high. About 65 percent of all firms in the sample reported that they had experienced one or more forms of criminal victimization during 2001. Thirty-three percent of all firms were violently victimized (robbery, extortion and protection), 52 percent suffered various forms of theft, 50 percent experienced fraud, and 7 percent other forms of criminal victimization. These are comparable to levels of business victimization in South Africa, which experienced similarly highlevels of violent crime over an extended period. In 1999, about 68 percent of South African firms exPerienced theft of goods, 52 percent experienced employee theft and 56 percent burglary2 . Violent victimization, such as robbery, was only marginally lower than in Jamaica. For some categories of property crimes (not involving the use of violence) the victimization rates were higher in some Eastern European countries (including Hungary and the Czech Republic). Some of the developed countries of Western Europe (such as the United Kingdom and France) that have traditionally had high levels of property crime also recorded greater prevalence of burglary and similar property crimes. 6.23 Some Jamaican firms experience crime on a regular basis and in multiple forms. About 27 percent of firms faced incidents of theft at least on a quarterly basis, of which 9 percent on a weekly basis. Twenty two percent experienced fraud at least on a quarterly basis. Nine percent suffered from violent victimization, and 7 percent were otherwise victimized, on a quarterly basis. 6.24 Violent victimization and Theft. Robbery, extortion, and protection are the main violent crimes that are directed at businesses. In 2001, 12 percent of firms were robbedat least once, of which 3 percent repeatedly. 6.25 Extortion and protection are probably the most serious violent crimes since, propagated by the emergence of powerful organized crime groups, they transform the environment in which businesses operate. In the case of extortion, the firm pays the extortionist in order to avoid other forms of victimization that the extortionist may threaten. In contrast, in the case of protection rackets, the person or group receiving the 21 For moredetails on survey methodology see Annex 6.1 and Harriott et a12003. 22 Quotedin Harriottet al. (2003). 129 payment provides a real service in protecting the firm from all criminal activity, not just the potential criminality of the protector. The growth of the protection racket, especially in Kingston, is associated with police ineffectiveness and the growth of a market for protective services. Those with expertise inthe use of violence and who have influence in the underworld, are well placed to provide these services. In these conditions, the criminal dons are presented with new opportunities to transform their operations into more sophisticated organized crime. Further expansion o f the extortion-protection racket i s likely to be accompanied by a further decline in the rate of robbery as the former i s more sophisticated, less visible and less easily detectable. In2001, about 5 percent of all surveyed firms were forced to pay extortionists, while 8 percent paid for p r ~ t e c t i o n . ~ ~ 6.26 Refusal to pay extortion-protection levies i s usually punished by burning down the non-compliant firm and puttingit out of business, or at least expelling it from the area that i s dominated by the extortionist group. In 2001, only 2 percent of the sample reported that they were victims of this crime. The non-compliant victims and other firms that were completely ruined by this form of crime would not have been detected by the survey. The survival bias in the sample therefore means that the data i s likely to understate the problem. 6.27 Extortion marks a break with the historical pattern of crime in Jamaica, which has been directed at victims from a similar class background as the victimizer, usually located in the poorer communities. Upwardly directed violent crimes, in which the poor violently victimize the rich, are still relatively few, but rising. 6.28 Theft and the various traditional forms of non-violent property crimes are less threatening, but nevertheless may severely burden weak firms. This i s particularly true in cases of multiple victimization involving violent and non-violent crimes (see Case in Annex 6.4). 6.29 Theft i s the most prevalent crime encountered b y firms, in the form of theft of cash (20 percent of firms) and theft of goods (43 percent), and appears to be positively correlated with firm size. Fraud i s also quite prevalent and takes the form of the use of counterfeit money (27 percent), presentation of forged checks (18 percent), use of forged credit cards (9 percent), sale of counterfeit products (7 percent), weight and measures fraud (13 percent), solicitation of funds for charitable organization (8 percent), and manipulation of payrolls and invoices (7 percent). The main perpetrators of some of these types of fraud are employees of these firms. 6.30 The costs of employee criminality are not restricted to the losses incurred from theft, corruption and the direct appropriation of the assets of the firm. They extend to the cost of policing the workers via more elaborate accounting systems, extensive surveillance systems, and the increased density o f security guards. For societies that are well endowed with social capital, these costs to business are much lower (Figueroa, cited inHarriott et al., 2003). 23 Under-reportingis likely since managers may not admit to the payingof extortion or protectionmoney. 130 6.31 Sectoral Patterns. The pattern of firm victimization may be linked to the degree and type of opportunities for crime in the sector. For example, firms operating in the financial sector are more vulnerable to employee and corporate fraud, and farms operating inthe agricultural sector to theft of goods. The size of a firm may also structure opportunities for crime, as well as variation in the capability to protect assets and prevent crime. 6.32 Tourism i s quite sensitive to crime, and the proportion of firms in this sector that are reportedly victimized i s quite high. The main crime against hotels was theft (hotel inventories present considerable opportunities for theft), reported by about 72 percent of the firms in the sector in 2001 (see Table 6.2). About 41 percent o f the firms in the sample reported that they were victims of violent fraudulent victimization (i.e. robbery, extortion, or some other method of illegally transferring their assets involving the use of direct or threatened violence). This i s higher than the level reported to the police and may include the victimization of hotel guests (rather than strictly the victimization of the firm). 6.33 Crimes against visitors are relatively low. In 2000, only 0.1 percent (or 103 incidents) of all visitors to Jamaica reported being victimized.24 Despite the high rate of violent crime in Jamaica, the low rates and prevalence of tourist victimization are explainedby the relative low crime rates intourist areas (with few exceptions). 6.34 The pattern of victimization in agriculture i s similar to that of tourism. Theft of goods (mainly predial larceny) was the most prevalent crime, experienced by 81 percent of agricultural farms in 2001. Farms are vulnerable to crime because their expansiveness and relative openness makes it difficult and very expensive to secure them. Official police records suggest that the incidence and rate of predial larceny has been steadily declining from 18.7 incidents per 100,000 citizens in 1990 to 10.9 per 100,000 in 2001. This reflects declining opportunities for crime that accompany the progressive decline of agricultural production and fewer farms operating. But for the remaining farms, the experience of victimization i s even more prevalent, as reflected inthe survey. 6.35 Consistent with the structure o f criminal opportunities, fraud was the most prevalent crime in the financial services sector. About 65 percent of the firms in the sample reported that they had been targets of fraud. Relative to the other sectors, they also reported the lowest incidence o f theft (5 percent) and second lowest incidence of violent victimization. 6.36 The pattern of victimization in manufacturing, distribution and construction sectors i s similar. Theft and fraud are equally prevalent in manufacturing (47 percent). Inconstruction, 44 percent and48 percent of the firms reported beingvictims of theft and fraud respectively in 2001. In the distributive trade, which i s characterized by finished products distributedby relatively small and vulnerable firms, the prevalence of theft and 24 This cannot be attributed to low levels of reporting as these are higher amongst tourists than local residents. Insurance coverage is more prevalent amongst tourists, and only recoverable if the incident i s reported to the police. 131 fraud i s greater, experienced by 53 percent and 63 percent of the firms in the sample respectively. The level of violent victimization is much lower in all three sectors. 6.37 Company size is also linked to a discernible pattern of victimization. Small firms seem to be more rone to victimization than large firms as they provide more opportunities for crime.2 P Since most entrants start out small, this acts as a barrier to entry for potential entrants, and inhibits growth. Size-based vulnerabilities may be accentuated by the area inwhich firms are located. As discussed in Section 111, there has been a general tendency for greater concentration of criminal activity in the urban areas and particularly inthe Kingston Metropolitan Area. Table 6.2: Victimizationby Sector in which Firm is located and Type of Crime (as % of firms in the sector that are victimized) Theft Fraud Violent Crime Total number of firms Finance 5 65 10 20 Tourism 72 43 41 32 Manufacturing 47 47 21 53 Agriculture 81 38 41 53 Construction 44 48 28 25 Transport & Storage 43 39 12 23 Entertainment 46 46 9 33 DistributiveTrade 53 63 24 79 Mining and Quarrying 8 Other 33 47 12 51 Total 52 50 33 377 Perceptionsof Risk 6.38 The perceptions of managers of the environment in which they operate and the risks of victimization to the firm are examined below. These perceptions are a measure of their levels of confidence and investment risk that are likely to influence business decisions. 6.39 About 29 percent of managers felt that the area in which their firm was located was either very unsafe (9 percent) or unsafe (20 percent). On the other hand, 49 percent felt that their firm was located in an area that was either "very safe" (9 percent) or "somewhat safe" (40 percent). O f those firms operating in the areas perceived to be unsafe, 43 percent of their managers felt that these firms were highly likely to be violently victimized. Interestingly, the perceived the risk of violent victimization (by robbery) in such firms was lower than the 66 percent risk perceived by firms in the whole 25 Firm size in Jamaica has fallen over the last twenty years, reflecting the decline of light manufacturing and plantation agriculture, and the parallel growth of small firms in the service sector. A firm employing fifty or more workers i s officially regarded as `large'. 132 sample. This finding i s consistent with the pattern of fear of crime found in other studies of the general population whereby sub-populations that are most at risk are not necessarily the most fearful of victimization. Familiarity with one's environment and having a system of social support may obviate dangers andrisk of victimization. 6.40 The decision making within firms may be influenced not just by the perceived risks to the firm, but also by the risks to its staff, including the managers. The fear o f criminal victimization at the workplace may also be an important motivation for individual action such as the migration of skilled personnel to other firms. Inthe case of family firms, it may be decisive in shaping decisions about the firm itself. 6.41 Examining the perceived risks of different forms of crime shows that about 42 percent of all managers felt that they were either highly likely (11percent) or likely (31 percent) to be murdered at the workplace. Even in the context of the high murder rate in Jamaica, this i s an alarming figure. However, much of the fear may be derived from the more general crime problem in Jamaica rather than perceived dangers specifically at the place of work.26 In terms of other forms o f violent crime, 49 percent felt that an assault on them was either highly likely (13 percent) or likely (37 percent). Moreover, about 66 percent felt that they were either highly likely (25 percent) or likely (41 percent) to be robbed. About 11 percent of respondents felt at risk of being a victim of extortion. About 62 percent and 33 percent felt that they were likely to be burglarized or victimized by fraud respectively. The concern with violent attacks i s viewed as being closely linked to efforts to dispossess staff of their property or the property of their firms. It does not seem to be linked with work related conflicts, such as violence by aggrieved workers. Conflict resolution and mediation efforts within the workplace are therefore not likely to dissipate these fears, although such efforts may be useful i s dealing with disputes between workers. Institutional Support 6.42 Given high victimization of firms, and high levels of the fear of crime among managers, institutional support from the criminal justice system and in particular the police i s vital. 6.43 Reporting i s the first step in appealing for institutional support. The level of reporting may be related to the expectations of the victimized population. Reporting i s high for robbery-burglary (85 percent) and fraud (60 percent) and low for extortion. Most of these reports are made to the police, since private security companies do not provide any investigative services and reporting does not seem to be motivated by attempts to recover losses from the insurance companies. For robbery-burglary, fraud, and arson, only 11 percent, 13 percent and 14 percent respectively of these cases were reported for insurance purposes (see Table 6.3). Reporting is thus based primarily on crime control expectations. 26A 1998survey indicatedthat 39% of the populationwere fearful of beingmurdered(see Harriott et al. 2003). 133 6.44 Police performance, when evaluated as the response to the last incident of crime experienced b y the firm, was generally regarded as satisfactory. On this measure, 37 percent regarded the performance of the police as being good and a majority of managers from these victimized firms regarded their performance as fair (32 percent) or poor (31 percent). When the evaluation of police performance is measured in relation to the different categories of crimes that were reported by the firms in the sample in 2001, it was regarded as good inrelation to the investigation of fraud, fair to poor for robbery (the most prevalent violent crime affecting firms), and poor for burglaries (the main reported property crime).27 It may be that police responsiveness i s related to its perception of the prospects for investigative success. In cases of fraud, the police are usually called after the suspect(s) idare discovered. Robbers usually leave behind witnesses who may provide the police with leads. Burglaries,on the other hand, may be relatively difficult to deal with as there are usually fewer investigative leads. This evaluation of police performance in relation to a single specific incident of crime may be taken as a measure of their responsiveness, but cannot be equated with a general evaluation of the performance of the police. Table 6.3: Reporting and Reporting Outcomes (% of total cases) Reporting Reporting Authority* Outcomes* Police Private Insurance Other Recovery Arrest None Security Company of items Extortion 35 80 0 0 0 0 0 50 Fraud 60 07 9 13 6 17 40 43 Robbery 85 96 10 11 2 19 22 66 Arson 85 0 14 14 - 100 Other 60 85 4 0 13 17 30 59 These categories are not mutually exclusive. 6.45 As the assessment of police performance becomes more general, the impressions of the victims and the general public tend to become less favorable (see Box 6.1 and Annex 6.3 and 6.4). In contrast, the evaluations of the manager-respondents in this survey seem to be more favorable than other evaluations of the general public, and this could be partly due to the perceived increased police responsiveness to the needs of the economic elite and those of their firms. Nevertheless, an area o f police work that attracts criticism i s the quality of their investigations incases that are put before the courts. 6.46 The courts are seen as not adequately giving the institutional support that i s needed to deal effectively with both criminal and civil cases. The process i s seen as being too long and time consuming. Many firms and individuals are therefore forced to find other ways of coping with some types of crime andbusiness relatedconflicts. *'A significant proportionof firms were very dissatisfiedwith police performance. About 42 percent of the firms that had reported incidents of burglary in 2001 regarded the performance of the police as "poor." The respectivefigures for robbery and fraud are 32 percent and 24 percent. 134 CopingStrategies 6.47 In response to the crime problem and limited institutional support, most firms have adopted a variety of coping strategies. The main elements of these strategies are target hardening (makingthe firm less vulnerable to crime), adjusting the organization of business activity to reduce opportunities for crime, and in some cases striking an accommodation with criminal networks. 6.48 Target hardening measures include installing special fencing, grill works, alarm systems and other such protective measures designed to make illicit entry more difficult. Criminal threats from within are countered by up-grading internal security and accounting systems. Security guards are used as part of the internal surveillance system as well as for dealing with external threats. In response to the demand for this service, over the last twenty years, the private security business has rapidly expanded. However, its role i s a very limited one, and which does not diminish the dependence on the police force. There remains a hope that the police may still be able to effectively control the crime problem. Many managers and their representative organizations are quite willing to enter into new relationships and partnerships with the police that may involve sharing the cost of new crime control initiatives. As yet, however, there have been no practical outcomes. 6.49 In areas where crime networks are most powerful and institutional support weak, new adaptations have taken place and an accommodation has been struck with "dons" of organized crime who offer protection services. As indicated in the cases below, these processes may be significantly altering the business environment in some sectors, especially in construction, where in some areas of the country it i s difficult to operate without striking an accommodation with the dons and/or cultivating protective political links. Extrapolating this trend, only companies in some relationship with criminals would survive in the construction sector or be able to undertake some types of projects. Organized crime has always exhibited very strong monopolizing tendencies. More generally, without more effective institutional support, more firms may resort to criminal adaptations and corruption such as defrauding their clients and tax evasion as a method of coping. 6.50 Other adjustments involve more directly changing the organization of business activity. A significant proportion of firms, have opted for closing before dark (37 percent). This practice could be particularly damaging in the manufacturing sector, where second shift production i s abandoned and productive capacity remains idle for much of the day. The fear of criminal victimization may also be altering employment practices. Residents of stigmatized inner city communities constantly complain that they are excluded from employment opportunities because they are seen as high risk employees. It may be argued that there i s a higher risk involved in employing someone from a high crime/ violence prone area as such persons may be coerced into facilitating robberies or other crimes. This "rational" discrimination may in turn further compound the crime problem in two ways. First, by reinforcing the exclusion of sections of the urban poor who already live in crime prone areas, and in so doing facilitating the justification for crime as a "survival" strategy. Second, the excluded are likely to resort 135 to the services of the crime dons in order to force firms to employ them, further compounding the crime problem (see Box 6.1). Box 6.1: Constructionfirm inKingstonMetropolitanArea Background This is the case of a family owned construction firm, which is located inthe Kingston MetropolitanArea. It was established in 1970 and i s mainly involved in the development of infrastructure and civil engineering works, including the construction of roads and housing. Its clients are usually government and private developers. It is a medium size company that employs 30 permanent workers and, on average, 400 temporary workers. Its revenue is approximately J$200 million annually. Crimeproblem The firm is challenged by a wide variety of crime problems such as the theft of construction materials, robbery of its payroll, fraud, and protection racketeering. More complicated is the problem of extortion which the company has experienced in a variety of forms. One form is that of so-called area leaders (usually the local party leader and/or criminal "don") and community residents demanding to be put on the company's payroll as a condition for permitting the construction project to proceed. This is simply a levy or tax that i s imposed on the firm for doing work in their area. In some instances, this problem is resolved by insisting that those making the demand at least appear to do some work. On the settlement of this problem, the negotiations then move to another stage. Most of these persons are usually unskilled with little or no experience of work. Yet they then demand, often with success, that they be employed as skilled workers at a salary that is commensurate with this category of work. The result is usually poor quality work, which in the case of roads and other infrastructure works i s usually counterproductive as these edifices tend to collapse under conditions of intensive use or flooding. The cycle i s completed with reconstruction taking place in a manner similar to the initial project. At times, these defective works have to be destroyed and reconstructed thereby further escalating the cost of construction. Refusal to comply with these corrupt practices may lead to the disruption of the project. These practices are not restricted to Kingston. May Pen, Montego Bay and other parts of Jamaica are also known for this type of activity. The company may, at times, reject these demands, and in some instances may accommodate them. Accommodation may also involve allowing area leaders and criminal dons to determine who (from their communities) will be employed on these projects. The local don may then extort payments from persons that he has advised or instructed the firm to employ. These payments are usually a percentage of the weekly salary of the workers. B y settling the matter in this way, the firm avoids disruptions to their project either as work stoppages or as constant demands for employment by community members. Where powerful organized crime networks are involved, even regular employees of the firm and other skilled workers who reside outside of the jurisdiction of the don, may also be required to pay a percentage of their salaries in return for permission to work in the area. On some work sites, party political competitiveness may result in violence. For example, on a recent project in a relatively safe section of Kingston, politically induced gang warfare erupted on the work site. The Company was contracted to construct several buildings on the campus of a tertiary institution. The temporary employees were drawn from the surrounding communities which have different party affiliations. At one time point, these workers were drawn from seven different communities. Workers from one area could not work on sites where residents from an opposing area were working. These employment monopolizing tendencies resulted in gang warfare. In this context, a work related dispute between workers and a subcontractor employed by the firm resulted in the death of the latter. The firm has also had to contend with other kinds of crimes. Payroll fraud is not uncommon. At times, supervisors attempt to extract overpayment for work done, or there may be fictitious names on the payroll. This is less detectable in construction where there is a large temporary staff that may change frequently over the life of the moiect. 136 In order to reduce its vulnerability to robbery, the firm would pay its employees by checks. Recently however, the banks have refused to offer this service to the company as they claim that the construction workers tend to disrupt business activity at the banks and are disorderly, refuse to conform to simple procedures such as joining the lines in the bank, and are rude to other customers and to the staff. I n some cases, conflicts between workers on the work sites are renewed in the banks. The result of this is that the company is forced to handle the payroll as cash and to bear the additional costs of contracting a security company to provide protection for the cash. Impactof Crime These conditions affect the operations of the firms in various ways: - Control of the workforce by criminal "dons" leads to poor quality work, an unreliable workforce and the inability to meet deadlines. - Intensive criminal activity has at times led to the company discontinuing some contracts and consequently losing income. For example, in the case of a government contract to buildhepair two schools, despite the security "provisions", there were significant losses due to theft and no reliable estimate of what the cost or time needed for completion would be. The military had to be used to complete the project. Even then, the army took 2 years and 9 months to complete a project that would normally take 9 months, and the fixtures had to be installed 6 times due to theft. - Increased cost of projects. On average, about 10 percent of the budget for each project is the anticipated cost of theft of materials. These costs are borne by clients, but are usually hidden from them. - Increased security costs. Private security at its main office costs approximately 0.5% of its annual revenue and this i s a relative minor part of the security costs o f the company. Much greater costs are incurred on the work sites. - The working hours of some employees are restricted by crime and violence in the areas where projects are located as well as in those areas where they reside. This impairs the work of the company, as some projects require an extended workday. Some skilled workers may even refuse to work in violence prone areas. InstitutionalSupport The firm regards the police as being fairly responsive to calls for assistance incases of employer-employee and employee-employee violence. More generally, however, they are not able to meet the policing needs of the firm. The experience of the firm i s that police units have a poor record in recovering stolen items and are unable to give preventive support. The company has no experience with the criminal court as problems are usually dealt with informally. The proprietor believes that it i s pointless taking formal independent action against offenders who criminally victimize the firm as lawyer fees are usually higher than the cost of the materials or cash that are stolen. The firm however relies on the courts to settle civilhusiness disputes and these are often quite lengthy. SurvivalTechniques Some innovative adaptations to the social environment seem to be occurring. In the case of this firm, they have attempted the following: - As noted above, the budgets of projects are inflated to compensate for theft and may also be inflated as theft under the pretext of compensation for theft. This has the effect of passing on the costs of crime to the client. - The company employs formal and informal security services and relies heavily on private security. - It has found a way to strike an accommodation with area leaders and dons and uses them to control the labor force. This i s a tension filled relationship that involves elements o f extortion directed at the firm, as well as partnerships, with criminal coercion directed at the labor force. Despite the problems discussed above, the company has no intention o f closing its operations. This i s a company that will find innovative ways of adapting to its environment and surviving. Source: Harriott et al. 2003 137 V. THE ECONOMIC COSTS OF CRIME The approach 6.51 Section Ioutlined the different ways in which crime can negatively affect society and the economy. This section attempts to estimate some of these costs to the Jamaican economy, for both the public and the private sector. The focus i s on the impact on business, since it i s key for competitiveness and long-term growth prospects. 6.52 The estimate of the cost of crime presented in this chapter i s a lower bound one, partly due to the longer-term impact that violent crimes such as extortion have in structuring the business environment in some sub-sectors. Box 6.1 above narrates how a construction company was forced to place incompetent workers as skilled staff on its payroll, resulting in poor construction, the need to re-build within a short period of time andhighly inflated costs. 6.53 Another general issue relates to the value o f stolen goods. It can be argued that stolen goods are not lost to society as a whole, and so should not be counted as a cost. Only the difference between the value for the original owner and the value for the criminals (which will be smaller, since goods and assets have specificity of use) should be counted as the cost to society. On the other hand, criminals spend so much time on illegal activity, which i s a social loss, and in equilibrium the value of goods should be equal to the opportunity cost of the criminals' time, so all property losses should be considered social losses (see Fajnzylber et a1 2000). It i s this approach that i s followed here. 6.54 While not analyzed in detail in this Chapter, the increasing influence of the drug trade and its linkage with violence needs to be mentioned. Drug related activities have been shown to induce crime and lead to increased homicides (for Latin America, see Fajnzylber et al. 2000), arising from turf-wars between different networks of producers and distributors. Some of the money from the drug trade i s spent in Jamaica on home construction, the establishment of legitimate businesses, importation of goods for distribution, and various services, leading to higher levels of employment and income for other people in apparently legitimate businesses. However, such illegitimate economic activities can hardly form the basis for long-term growth. While these activities contribute to the economy, they are also giving greater impetus to violent crime, which, as will be seen below, imposes a major cost on society.28 The police estimates that drug- related killings now account for more than 20 percent of murders annually. Some of the killings labeled as `reprisal' are probably also rooted inthe drugtrade. As the importance of illegal activities in overall economic activity expands, there will likely be more conflicts as the large sums of money and the lack o f formal contracts encourage defection from verbal agreements. 28 In Belmont, Westmoreland, it is suspected that the drug trade (transshipment of drugs from South America) has fueled unprecedented economic activity, including constructionof new homes and purchase of new motor vehicles. At the same time, an otherwise quiet fishing village has had a rapid increase in murders. 138 6.55 The illegal economic activities of transnational networks rooted in some Latin American countries have generated considerable problems for legitimate business. For example, drug trafficking may contaminate legitimate exports leading to security measures that slow down the processing time of perishable products. The consequent delays in delivery and other problems will tend to increase the cost of conducting business internationally. The increases in costs imposed on legitimate traders might over time drive some out of business (see also Chapter 7). Measuring the impact of crime on economic activity 6.56 The economic impact of crime i s estimated by aggregating the following: (a) medical ex enses incurred on crime-related injuries, by both Government and individuals2[ (b) loss of output arising from death and injury; (c) cost of security provision by public and private entities based on the premise that even though such output i s part of the economy's productive activity, it does not produce directly beneficial goods, and involves high opportunity costs; (d) direct business losses of firms arising from crime, such as extortion, fraud, theft and looting; and (e) other costs, such as likely shut-down of firms, and impact on investment and expansion intentions. The data sources for this exercise include government budgets and public records, and various official reports (SLC, ESSJ). Private costs are more difficult to measure, especially those incurred by business. The business victimization survey, discussed earlier, was conducted to assess these private costs. Table 6.4 provides an indicative summary of the quantitative impact of crime, which will be amplified inthe following sections. FirmresponseinJamaica-some general survey results 6.57 Protective measures. To deal with the threat of crime, most firms undertake protective measures (see Table 6.5). (See also Table 6.7 and sub-section below on business practices and prospects, where firms cite the increased cost of security as the most frequent impact of high crime). These include the installation of metal grills on buildings (58 percent of firms), special fencing, and hiringunarmed security guards (49 percent). Just over 30 percent of companies either hire armed security guards or install electronic alarm systems. Many companies (between 33 and 40 percent, depending on the industry) also close before dark andor have taken steps to improvehpgrade their accounting and record-keeping systems to reduce employee crime and fraud. Again, the method of security employed depends on company size. Whereas small firms tend to install metal grills and fence the premises, large firms use fences and security guards. Seventy-five percent of very large companies (those with annual revenue of J$lOO million or more) hire unarmed guards, while 63 percent hire armed guards. Almost 60 percent of large companies use armed guards. For small companies, the costs of hiring security are relatively high, and the need for this type of protection i s also lower. Only 29 Since human life is valuable in itself and i s (even in purely instrumental terms) worth more than its contribution to the economy, this method only produces a lower bound estimate of what crime costs the economy. 139 30 percent o f micro-enterprises (those with annual revenue of less than J$5 million) hire guards. Sectorally, it i s firms in banking/finance that most tend to use multiple preventive measures to combat crime, with 90 percent hiring armed guards, 85 percent installing alarm systems, internal security, and upgrading accounting. Table 6.4: Annual Impact of Crime, Summary Expenditure Cost I.Healthcosts t Lost Productiont Public Expenditureon Security 3.7% Of GDP 11. Private Expenditure on Security Average 1.3%of revenue Micro firms (less than J$5 million revenue) 17%of revenue Average size firm 7 %of revenue Large firms 0.7%of revenue 111. Direct Costs Extortion, Fraud, Robbery/Burglary, Arson Micro firms (